Onex Stub OCX-CLS
November 18, 2003 - 10:19am EST by
gary9
2003 2004
Price: 11.52 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,800 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

If you have ever dreamed of getting free “points” on a $1.5B private equity fund, read on . . . .

Onex is a Canadian investment company controlled by Gerald Schwartz. According to TD Newcrest, Onex has an NAV of C$20.51 comprised of cash (C$8.84); interest in Loews Cineplex (C$4.69, valued at 7x EBITDA); interest in Celestica (CLS.TO C$19.60, C$3.33, at market) and other investments. There are about 165mm fd shares and Onex trades at C$14.85 for a C$2.4B market cap. The current 28% discount to NAV is toward the high end of the historic range (15%-35%).

If you short out the public contract manufacturer Celestica (short .17 shares CLS.TO or CLS on Nasdaq), which looks like a good idea as they have been poor operators with low takeover appeal, you own the Onex stub at $11.52, a 33% discount to stub NAV.

Based on our recent meetings with the company, we have reason to believe that the NAV is understated by at least C$2.24 (11%) and that the discount is likely to narrow. If we adjust Onex’s NAV upward by C$2.24 to C$22.75 and the current 28% NAV discount narrows to 20%, OCX.TO should trade at C$18.20 (24% upside) and the stub should trade at C$14.83 (31% upside).

The principal reason for the NAV understatement is that analysts have failed to incorporate the probable future fees from Onex’s currently-proposed external US1.5 billion private equity fund. Onex will be the GP of the fund as well as the lead investor ($300mm-$400mm commitment). As currently proposed, the GP will receive a 2% management fee on committed capital and a 20% override of profits. We understand they have already attracted several major institutional commitments and are very likely to have at least a first closing on this fund by year end. The present value of these potential fees is easily estimable.

The management fee on US$1.2B of outside capital should start to add US$24mm (or C$31.2mm) to Onex revenues beginning next year. The full fee will be earned for an estimated 6 years and can be supplemented by additional management fees from investments which could last for many years more. Investment realizations over the years would begin to reduce the fee base. As these fees are unusually highly-probable, we discount back at a low rate (5%) and get to a PV of approximately C$1.45.

The override portion we estimate by assuming a 15% rate of return on US1.2B over an 8-10 year expected life of the fund, and discounting back at 15%. These assumptions seem appropriate given Onex’s very successful long-term track record. For those who don’t know, Onex is basically the KKR of Canada. Since 1984, they have a 29% compounded annual IRR on over $4.3B in private equity investments. The estimated PV of the carried interest is C$1.35.

We assume 20% “leakage” to management of these fee streams through bonuses, increased expenses, etc. to arrive at net NAV adjustments of C$2.24. This does not include additional accretion of about 10-15 cents per share each year if, as we expect, the company continues to devote C$100 million per year to stock repurchases.

Expected returns on Onex’s invested capital could also add incrementally to NAV depending on your assumptions. We choose to treat this as the first positive catalyst for narrowing of the NAV discount. The formation of this external fund is definitely a signal that Onex finally has a roadmap for getting its cash deployed.

Other actual catalysts, we think can impact the NAV discount in the near-term are (1) the closing of the fund’s first two investments - Magellan (in which they already have a big mark-to-market gain) and Aeroplan; (2) the pending spinoff of Canadian Loews assets into an income trust; (3) perpetual, accretive stock buybacks by Onex (they have spent C$94mm year to date).

Other potential catalysts under consideration at Onex are (1) distribution or other monetization of CLS stake; (2) an IPO of Loews in the US.

Catalyst

1) the closing of a new external private equity fund (2) the pending spinoff of Canadian Loews assets into an income trust; (3) perpetual, accretive stock buybacks by Onex (they have spent C$94mm year to date).

Other potential catalysts under consideration at Onex are (1) distribution or other monetization of CLS stake; (2) an IPO of Loews in the US.
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