Asset Class – June 2008

Private equity provided an 18.6 percent return for the Ontario Municipal Employees Retirement System last year, allowing the Canadian pension to beat its overall benchmark. Amanda Janis recently met with Paul Renaud, head of OMERS Capital Partners, to discuss the methodology his in-house investment team employs and his thoughts on industry trends.

OMERS Capital Partners catapulted into existence in 2004 as the $48 billion (€31 billion) Ontario Municipal Employees Retirement System dramatically shifted its attention to alternatives.

Looking to move away from a heavy 80 percent allocation to publicly traded stocks and bonds, and more towards real estate, private equity and infrastructure – asset classes in which it had been successfully investing for years – the Canadian pension upped its alternatives target to 35 percent from 18 percent and created three investment companies, one for each asset class.

OMERS clearly didn’t regret the decision. It recently reshuffled its allocation mix and again increased its alternatives target – this time to a weighty 42.5 percent, with the private equity target 10 percent, infrastructure 20 percent and real estate 12.5 percent.

“The mandate of OMERS is to increase the investments in alternatives but we don’t have a goal to get there by a certain date, it’s better to make good investments rather than chase targets,” says Paul Renaud, president and chief executive of OMERS Capital Partners (OCP), the pension’s private equity investment arm.

At the end of 2007, OMERS’ private equity investments constituted just less than 7.5 percent of its assets, leaving OCP room to grow.

“But we have been growing,” Renaud says. “Three years ago we had about $1 billion under management, today we’ve got $3.8 billion under management, so we’ve grown a lot.”

Like many Canadian pension plans, OMERS’ private equity arm doesn’t just make fund investments and occasional co-investments, but also does deals directly. OCP is a private equity firm unto itself.

“We’re getting a lot more traction these days as a direct, majority-owned investor,” Renaud says.

Last year, OCP paid around $240 million, including the assumption of some $26 million in debt, to take private Golf Town, Canada’s largest golf retailer structured as a Canadian income trust. The deal added a 32-store golf equipment retail chain to its direct investment portfolio, which comprises a diverse array of companies including press release distribution company Marketwire, formerly CCNMatthews, and CHG Healthcare, a physician staffing service.

OCP divides its 16-person investment team twofold, with one group dedicated to direct investments and coinvestments, and the other focused on making fund commitments.

“If we’re going to do a co-investment on a particular transaction, the relationship comes from our funds team but we take the skills and the people from our direct team to get involved in that, to do the due diligence, to do the models, because it is a different model than committing to a fund manager,” says Renaud.

A larger portion of the team is devoted to OCP’s direct investment programme, simply because making those investments is more time consuming, he adds.

When leading direct deals, he explains: “You’re in charge, you’re leading the negotiations on the agreement, you’re sourcing the transaction, you’re coordinating all the due diligence, and you’re working with management post-acquisition to add value.”

As fellow Toronto-based pensions the Canadian Pension Plan Investment Board and the Ontario Teachers’ Pension Plan have scaled up their direct investing activities, they’ve opened offices abroad – a step that might not be too far down the road for OCP.

“We’re not quite at the size where we feel we need to have an [overseas] office but we are contemplating it,” Renaud says. “I wouldn’t be surprised if in the next 24 months we establish [an international location]; probably a logical presence for us would be somewhere in Europe.We have several relationships in Europe and Asia.”

Those relationships, however, tend to be more on the fund and co-investment side.

OCP invests in all sorts of funds – mezzanine, venture, special situations, etc. – with diverse strategies in terms of size, geography and sector [see fact box on p. 44 for a sample of fund managers].

“Most of our funds tend to [invest] in a variety of segments so that we don’t get too much exposure to any one industry,” Renaud notes.

Buyout funds, in their varying shapes and sizes, constitute the bulk of OCP’s fund commitments – anywhere from 65 percent to 85 percent.

“But things do change,” Renaud says. “The way I look at it is in any one of those categories, we can be anywhere from zero up to 10 percent.”

Market and general economic conditions will also influence investment strategies.

“We’ve raised our profile in what I’d call distressed situations in response to the marketplace today,” he says, noting that OCP has also decreased its mezzanine fund commitments.

Mezzanine funds became less attractive as the amount of senior lending increased, amplifying risk for mezzanine debt holders, he explained in a later email.

And, he added: “It was difficult to obtain equity sweeteners (warrants) that provided more upside for the mezzanine debt holders. This is changing again with the debt crisis.”

But what changes most within the fund programme is the geographic strategy, Renaud says. “We’re dedicating more effort to raise our investment exposure to Asia.”

OCP has roughly 60 relationships with fund managers, about 25 of which Renaud calls “core” relationships.

Choosing funds, first and foremost, means looking for managers with proven track records of top-tier performance, he says. Though OCP doesn’t hesitate to hire advisors and consultants when examining coinvestment or direct investment opportunities, its fund programme is a different story.

“When we select managers we tend to do that on our own. We’ve been fund investors for quite some time and we are very confident in our own ability to execute that.”

OCP factors in the quality and depth of management teams, the way GPs share economics with each other, a firm’s succession planning, and its alignment of interest with LPs in terms of the GP’s contribution to the fund.

“And we consider co-investment opportunities,” Renaud says. “That’s important to us when we evaluate a manager – to assess the likelihood we’ll be presented with co-invest opportunities.”

OCP will also cast a discerning eye toward what firms say about themselves.

“Everybody says they have proprietary deal flow, but is it really proprietary? Almost everything in private equity now is done by auction, it’s just the name of the game,” Renaud says.

His team also examines how GPs interact with their portfolio companies.

“We do due diligence to confirm an investment thesis that they operated under; how did they execute that thesis? We’re talking to portfolio companies to see how the relationship is with the GP team that invested in their business. Are they really adding value? Are they being successful?”

Basically, OCP does whatever it takes to satisfy its requirement of finding quality teams, he says. And it doesn’t shy away from refusing to reup if it feels the manager no longer meets its criteria.

“There’s a number of funds in the last few years that we haven’t reupped on for a variety of reasons-could be management changes, could be succession issues, could be poor performance,” Renaud explains. “If we become very uncomfortable with what’s going on with the general partner, we’re not afraid to say no. But more often, we’ll re-up than not.”

Prior to joining OCP, Renaud held senior financial management positions at publicly traded companies. Most recently he was chief financial officer of CAE, a provider of simulation technologies and integrated training services to airlines, aircraft manufacturers, defence forces and marine customers.

He knows well the demands put on companies to meet analysts’ quarterly earnings expectations and sees great merit in the fact that private equity is spared this task.

“Sometimes making short-term decisions to meet quarterly expectations may not be in the best interest of the company,” he says.

He also calls private equity advantageous because “you can tolerate more leverage in your structure”.

When asked about the asset class’ disadvantages, he gives pause.

“Disadvantages to private equity? I cannot think of any.”

But, Renaud adds, the industry must tread carefully as its success and public notoriety swells.

“The more successful you get, the more attention you bring to yourself. I think the industry needs to be proactive to make sure that it is being responsive to [public or legislative] concerns that are being raised when they’re being raised,” he says.

If not, or if scandals ensue, the industry risks greater regulation, he cautions. “You don’t want to have any scandals because it’s going to bring all the scrutiny that the public companies have gone through that led to Sarbanes-Oxley and all the legislation around governance.”

He is slightly less concerned about negative public perception of the asset class.

“Those pressures are always going to be there. Eighteen months ago it was scrutiny on all the club deals,” he notes. “I would say now that the amount of private equity investment has really slowed down since the debt crisis, you’re hearing less about that than you were. But, you know, any public disclosure that’s negative tends to tarnish the industry.”

That said, the allegation that private equity ownership harms companies or workers doesn’t make sense to Renaud.

“The biggest fear about private equity is always that you go in and you slash and burn and lay off people,” he says. “Many studies have been conducted that show the opposite, that private equity in fact over the long term is adding value to companies and growing companies.”

He acknowledges that private equity firms sometimes restructure businesses, which can result in lay offs. “But generally that restructuring is to make the company more competitive so it can survive. If you don’t go in and restructure and get some costs down, you might not even have a company anymore.”


•The Ontario Municipal Employees Retirement System (OMERS) was established in 1962 to serve local government employees across Canada’s Ontario province. •Key managing directors at OCP include Don Morrison, head of the direct/co-investment team, and Martin Day, who manages more than ten fund relationships in Canada, the US, Europe and Asia.
•The pension today represents 910 employers, 380,000 members, retirees and survivors, including municipal workers, firefighters, police, transit workers and emergency services staff. •Private equity funds in which OMERS regularly invests include those managed by Apax Partners, HSBC Private Equity Asia, Paul Capital Partners, Hellman & Friedman, Terra Firma, Charterhouse Capital Partners, Tricap and Friedman Fleischer & Lowe.
•It has invested in private equity since 1989, but OMERS Capital Partners (OCP) was launched in 2004 as the firm’s in-house investment arm. The plan recently raised its alternatives allocation target to 42.5 percent. •OCP’s direct investments include: Marketwire, a press release distribution company; Cookie Jar, which creates and distributes non-violent programming and supplemental educational products for children; and a 20 percent stake in Affinia, a manufacturer and distributor of after-market components for vehicles.

In fact, there is a further element to what might be called the Apax distillation process. The firm is no different from many rivals in identifying sector specialisations, of which it has five: technology and telecom; retail and consumer; media; healthcare; and financial and business services. But what Halusa clearly takes pride in is the rigorous analysis the firm conducts into where the best opportunities lie within each.

“Throughout 2005, 2006 and 2007 we maintained our traditional investment rate. We’re very happy not to have been seduced into the mega segment. It meant that we could carry on through and past the credit crunch with no slowdown.”

He says: “We have very big sector teams, over 25 per industry, and they focus on sub-segments of which they have a deep understanding and in which they have a deep network.” What this means is that “it’s clear what an Apax deal is. The number of potential deals that come out of the funnel is not that many.”

The Apax approach is, says Halusa, “thesis-driven rather than opportunity-driven”. Adding that this process enables the firm to identify “secular growth trends”, he offers a number of examples. One he cites from the recent past is the shift within the media sector from print to online, which led the firm to purchase a 49.9 percent stake in Trader Media Group in March 2007 for £675 million (€857 million; $1.3 billion). Trader Media is the publisher of Auto Trader, which has the largest market share in the UK of online classified car advertisements.

Perhaps the greatest significance of seeking to identify these so-called sub-segments is that it means no sector is ever attractive or unattractive per se. This effectively challenges some traditional notions, such as the retail sector being off-limits during a consumer downturn. “In every market, there is always a trend,” Halusa maintains. “In the case of retail we are seeing moves to convenience, online shopping and a polarisation between value and luxury.”

In its determination to unearth a trademark Apax deal, it is clear that the firm will not necessarily be diverted by macro developments such as a credit crunch or economic slide – which, it might be argued, represents impressive dedication to the cause. Halusa points out that, of the 12 deals the firm has so far completed from its latest fund, all but one have been signed following the turmoil that arose in the debt markets in the middle of last year. “Throughout 2005, 2006 and 2007 we maintained our traditional investment rate,” says Halusa, before adding: “We’re very happy not to have been seduced into the mega segment. It meant that we could carry on through and past the credit crunch with no slowdown.”

Particularly for deals at the lower end of Apax’ target deal size range, Halusa maintains that debt funding can still be found: “It’s more difficult to get, it’s more expensive and there’s less of it – but it’s still available.” The claim is apparently supported by a number of the firm’s recent deals, including: the buyout of US generic pharmaceuticals business Qualitest & Vintage Pharmaceuticals for an undisclosed sum in November 2007; the following month, the £1 billion (€1.4 billion; $2 billion) acquisition of UK media group Emap alongside Guardian Media Group; and the $1.4 billion take-private of US healthcare software firm TriZetto in April this year.

According to Halusa, all three deals featured large debt components at an average debt-to-equity ratio of around seven times, which he adds “is not bad for the current environment”. An environment, he adds, where banks may no longer have a deep syndication market to sell down to, but where they are nonetheless prepared to club together to provide sizeable chunks of debt that will subsequently be retained on balance sheets. He also points out that in deals such as Emap (Guardian Media Group) and TriZetto (Blue Cross Blue Shield), “you can use the corporate balance sheets of partners to raise finance”.

Furthermore, Apax’ $1 billion acquisition of Israeli dairy products manufacturer Tnuva in January this year demonstrated the way in which local banks have increasingly stepped up to the plate to fill the funding gap left by their credit crunch-affected international counterparts. In this case, three Israeli banks – Bank Leumi, Israel Discount Bank and the First International Bank of Israel – formed an Israel-only banking syndicate which reportedly provided between $600 million and $700 million of debt finance.

While the evidence of deals such as these appears to support Halusa’s assertion that in the submega segment “not all the banks are closed for business”, he points out that Apax is not reliant on playing the leverage game and is happy taking minority stakes depending on the circumstances.

He cites the example of CME, a TV broadcasting company with networks in six Central and Eastern European countries, in which Apax invested $190 million in August 2006. Although this gave the firm a stake of less than 8 percent, through a limited partnership with the Lauder family it has almost 65 percent of the voting rights together with two board seats. “You can’t measure influence by stake size,” concludes Halusa. “This was a well constructed deal, we had a good relationship with the board and it was very much a value creation opportunity.”

Through this example and many others that he has at his fingertips, Halusa is able to build a compelling case for Apax having neatly sidestepped the more debilitating effects of the credit crunch. But thoughts of complacency are swiftly dispelled when he says: “I’m never happy. I’m paid to constantly worry about the future of the industry and the competitive position of Apax.”

Much of this worrying is done behind closed doors rather than in public, say those close to Halusa. Says one influential limited partner, who has known him since his youth: “Martin doesn’t have a big ego. In this business, some GPs need to always be in the limelight. He is focussed purely on wanting to do what’s right.” The same source describes him as “a hard worker, always available, who leads by example and sets very high standards for people. He’s tough but fair.”

“I’m never happy. I’m paid to constantly worry about the future of the industry and the competitive position of Apax.”

He’s also ambitious: “There is a segment of the asset class emerging that is global and is able to add value precisely because of its global footprint.We want to be the leader in that segment,” he says.

To which end, Apax has been busily adding resources around the world. In the US, the firm added 15 professionals when it merged with mid-market buyout shop Saunders Karp and Megrue in early 2005. Halusa says the firm now has a 23-strong team in the States “which makes us the largest of the European private equity firms operating there”.

Halusa is asked whether planting a flagpole in the US was more to do with fulfilling the global mandate than offering differentiation in a crowded market. “The US is the most competitive market in the world, and it didn’t need another buyout house entering the fray,” he acknowledges. However: “We do bring our sector expertise. We’ve completed deals like Tommy Hilfiger, Qualitest and Hub International and none of these businesses had offers from any other private equity firms. This demonstrates that even in the US we can find proprietary deals below the radar.”

Furthermore, he continues, the global presence is itself a differentiator that can assist portfolio companies. “In a globalising market, they can use our help outside the US – for example, our relevant sector teams in Europe and Asia can assist with add-on acquisitions and/or developing manufacturing operations.” And when it comes to adding value, Halusa points out that the industrial or management consulting backgrounds boasted by around 80 percent of Apax’ deal professionals must be considered a strength – as well as a contrast with the bias shown by many other large funds towards those with banking pedigrees.

“The industry now plays such an important role in national economies. You can’t afford to be painted as value destructive, as a ruthless company interested only in creating value for a narrow shareholder base. We must work hard to explain that this picture is not the true one.”

In Asia too, Apax is aiming to add value by helping companies with their global growth aspirations: “Emerging companies in China and India want to develop major global competitive positions.” The firm opened an office in Hong Kong in 2005 and in Mumbai the following year. Growing rapidly in the region is clearly a priority for Halusa given his revelation that “in ten years’ time I would expect us to have the same number of professionals in Europe, the US and Asia”.

While his own firm’s geographic expansion plans are well under way, Halusa is aware that the process of globalisation is not celebrated by all. Aside from how to ensure the continued well-being of Apax, the other issue taxing his mind – as alluded to earlier – is the future of the industry. And he is painfully aware that private equity continues to be sensed in certain quarters as a malevolent phenomenon.

“The public perception is one of the things that I am most worried about,” says Halusa. “The industry now plays such an important role in national economies. You can’t afford to be painted as value-destructive, as a ruthless company interested only in creating value for a narrow shareholder base. We must work hard to explain that this picture is not the true one.”

One can’t help thinking that Sir Ronald Cohen, whose personal focus now is on investment in deprived communities, would undoubtedly agree.

Speaking of pictures: in the shiny new Apax reception area, Cohen still has a place. On one of the walls hangs a portrait of the man, on which he himself has scribbled the words: “You have the baton now and you are on your way to winning the race”.

Few would question that a distinctive Apax, shaped by Halusa, has emerged over the last four years. Equally, no-one should doubt the role of the past in determining the firm’s present and future. This has been a gentle revolution.