Monday, July 19, 2010

Onex, CPPIB Unite in Bid to Buy U.K. Firm

Tara Perkins of the Globe & Mail reports, Onex, CPPIB unite in bid to buy U.K. firm:

Onex Corp. and the Canada Pension Plan Investment Board are joining forces on the proposed takeover of a major British manufacturing and engineering company, just as the U.K. begins its own “hollowing-out” debate.

Toronto-based Onex and the CPPIB have not launched a formal bid but have proposed a deal, worth more than $4-billion, for Tomkins PLC. Due diligence on the company is now “at an advanced stage,” Tomkins said in a statement Monday.

The proposed takeover comes as North American suitors take advantage of a sluggish British pound to target U.K. companies. Earlier this month, for example, the Ontario Teachers’ Pension Plan closed its £389-million ($625-million) acquisition of Camelot Group Ltd., which operates the U.K. national lottery.

Coupled with the lingering effects of the global recession, fears are mounting that a number of British companies will be scooped up by foreigners.

While the concern has not hit the level witnessed in Canada in 2006 and 2007, when the Canadian business community was consumed by the “hollowing-out” debate, it’s unusual for the British to be bothered about this issue.

The tables have turned and Canada now finds itself portrayed as one of the prowling foreigners. But it’s the country’s pension plans and private equity players, not publicly listed corporations, that are on the hunt.

“In Canada, our corporate profits have rebounded fairly strongly and our credit markets are still flowing,” said Toronto-Dominion Bank economist Francis Fong. “And of course the dollar is providing a pretty significant boost.”

While the pound has depreciated and the Canadian dollar has surged since 2007, “it’s more about the ability of firms to find funding,” he said.

It was Chicago-based Kraft Foods Inc.’s $20-billion purchase of Cadbury, which closed in January, that first ignited concerns in Britain, which has traditionally been secure in its business prowess and hasn’t been worried by takeovers.

An independent takeover panel is in the midst of a review of the relevant laws, which Business Secretary Vince Cable has suggested are too loose, and the new government is looking at the issue. “I want to throw some sand in the takeover process,” the Daily Mail quoted Mr. Cable as saying this month. But, he added: “We don’t want to put up a sign that says: ‘Britain is not open to business.’”

There is discussion about whether a greater proportion of the shareholders of a target company should be required to approve a deal, or whether higher merger fees should be used to curb the flow of deals. Those pushing for a new regime of takeover laws are already dubbing them the “Cadbury Law.”

“Foreign firms swooped on two British energy and industrial giants with takeover bids worth £9.3-billion today, raising fears that another swath of British assets will fall into the hands of overseas owners,” the Evening Standard said Monday. In addition to the bid for Tomkins, International Power said talks have resumed about a reverse takeover by France’s GDF-Suez.

Just as a weak currency shouldered much blame in Canada’s hollowing-out debate – which raged after the takeovers of a series of blue-chip firms such as Alcan, Falconbridge, Inco and Dofasco – the weak British pound is being pointed to in the U.K.

The financial crisis took its toll on Canada’s pension and private equity players, but the pain they felt is overshadowed by that of many major financial players and corporations in other countries. The International Monetary Fund is projecting worldwide economic growth of 4.5 per cent this year, with Canada’s pegged at 3.6 per cent while the U.K. economy is expected to grow by 1.2 per cent.

Canadian pension funds are gaining new clout internationally because of their size, sophistication, and ability to partner up and work together, Charles Baillie, the former CEO of TD Bank who is now chairman of Alberta Investment Management Corp., said in an interview last week. “You’ll see much more international exposure because of the ability to band together and make meaningful bids.”

This time around, CPPIB has joined forces with Onex, which has a history with auto parts companies, such as the acquisition of the beleaguered Automotive Industries Holding Inc. Onex turned it around and sold it at a profit to Lear Corp. Tomkins’ businesses stretch from auto parts to bathtubs.

Tomkins also said Monday that its sales improved during the first half of 2010, but it’s unlikely that it will be able to keep up the momentum in the second half of the year due to “global economic uncertainty coupled with recent downwards trends in some macro indicators.”

The company’s CEO, James Nicol, 56, is highly respected in Canada. He left his job as president and chief operating officer of Magna International Inc. and joined Tomkins in 2002. Tomkins’ finance director, John Zimmerman, 46, worked in Toronto for Braxton Associates in the early 1990s. Both men sit on Tomkins’ board.

Interestingly, Philip Inman of the Guardian reports, Canadian pension funds move in as UK counterparts sell up:

As domestic pension funds sell their stakes in British companies, their place is increasingly taken by pension funds from Canada.

The $127bn (£84bn) Canada Pension Plan Investment Board, which is bidding for Tomkins, already owns stakes in about 35 companies including chemist Alliance Boots, US retailer Dollar General, internet phone operator Skype and US phone-equipment maker Avaya.

The pension fund manager, stung by a near 20% loss in 2009, has made offers for a string of companies hit by the financial crash and directs 25% of its holdings into private equity deals – more than any UK pension fund.

In the past year it bid $5bn alongside TPG, one of the most aggressive US private equity firms, for IMS Health of Connecticut.

Buying Tomkins, which is described by several analysts as a bargain, would add to a growing list of major stakes in large corporations by Canadian pension funds.

The Ontario Teachers Pension Plan holds a 27% stake in Northumbrian Water and was rumoured earlier this year to be supportive of a full takeover. The latest speculation allies the Ontario fund with the Abu Dhabi Investment Authority to take the utility private.

In March the Ontario fund spent £389m buying the lottery operator Camelot after it beat private equity firm CVC in an auction.

The Canada Pension Plan is the equivalent of the UK's state second pension, formerly known as Serps, with one key difference. In the UK, national insurance contributions are used to pay current pensioners and the remainder is diverted into general government spending. The Canadians take the remainder and invest it.

The pension plan's investment board is a separate unit with a constitution that allows a wide range of holdings.

A focus on large, longer term purchases dates back to the 1990s when the fund decided its size warranted diversifying into lucrative private equity-style deals. Returns between 2004 and 2007 averaged more than 10%.

Some UK funds have attempted to mimic the success of the Canadian funds with increased support for private equity and hedge funds.

The University Superannuation Scheme, which provides an occupational retirement income for academics, has boosted so-called alternative investments to close an £8bn deficit.

But the culture of UK funds and many of the rules surrounding scheme funding have discouraged direct investment in companies. Until a few years ago most occupational schemes were more the 70% invested in equities with the remainder in cash, property and bonds.

The steep stock market decline of 2003 and accounting rules changes encouraged fund trustees to cut the risk of falls in value with a shift from shares to fixed income bonds.

Critics of UK funds argued the move, while it minimised the impact of declining stock markets and avoided the steep falls that hurt the Canadian funds, effectively locks them into low growth investments and prevents them from making strong gains in the future.

It's true that UK funds have adopted a liability-driven investment approach, moving more towards fixed income and allocating less to public shares. Some UK funds have shifted more assets into alternatives, but most funds have cut risk across the board.

So what's the right thing to do? It depends. The Canada Pension Plan (CPP) is a partially funded plan and the CPP Fund (CPPIB) is in an enviable position because contributions are expected to exceed annual benefits paid through to 2021 and there is no need to use current income to pay benefits for another 11 years.

Moreover, despite the setback in 2008, CPP assets have grown over the last ten years, a point made by Jean-Claude Ménard, Canada's Chief Actuary in his testimony at the House of Commons Standing Committee on Finance last April:

The average pension fund return for OECD countries was negative 19% (nominal) for the first ten months of 2008. The CPP Fund declined by $13.8 billion over the final nine months of 2008. Still, the CPP assets of $111 billion represent four times the annual benefits paid. In comparison, ten years ago, the assets represented less than two times the annual benefits paid.

In this environment, it is important to reconfirm that the structure and design of the first two pillars of Canada’s retirement income system is unique and will allow the OAS Program and CPP to fare better than many of their private pension counterparts. In addition, steady-state funding, which is the partial funding approach employed by the CPP, remains the optimal funding approach for the CPP.

Although the financial markets are currently quite volatile and the value of CPP assets will fluctuate over the short-term, it is the ongoing contributions made by working Canadians in addition to long-term investment performance that will determine the Plan’s ability to meet its commitments to plan members.

As I've stated it before, a handful of funds like CPPIB, are able to take on more liquidity risk than more mature pension plans that are managing assets and liabilities more closely. Those funds are not able to tie up a big portion of their assets in private markets because they need the liquidity to pay out benefits.

And what can go horribly wrong for CPPIB? One word: Deflation. If a protracted period of debt deflation engulfs the developed world, then CPPIB will be sitting on a ton of public and private equities that will be losing value.

Who will be in a better position if a long deflationary era awaits us? Funds that allocated to high quality fixed income assets, because the only thing that will protect your downside if deflation develops is long-term government bonds.

Are CPPIB and other Canadian pension funds going on an overseas buying spree doing the right thing? I think so. Given the strong Canadian dollar, and the expertise to co-invest in private markets, they should be putting some of the long-term capital to good use. Let's just hope that deflation doesn't rear its ugly head.


A senior pension officer sent me this comment:

If you compare CPPIB's performance to bond returns since its inception, the bonds did better. The creation of CPPIB and taking on equity risk has not, as yet, provided Canadians any benefit. No one seems to want to acknowledge this. Private or public equity is a moot point, and it appears privates underperformed publics, although it is hard to get this data from their reports, but it is certainly the case on an IRR basis.

Allowing these failed non-taxed pools to crowd out strategic industrial (taxable) buyers of important assets is bad public policy and anti-capitalist. Onex and others are also largely representing non-taxable investors. At one time PE arbed the tax advantage to its investors benefit, now it just overpays and the sellers get the benefit. This is all unsustainable.

These are legitimate points, however, CPPIB will argue that over the long-run, taking on public and private equity risk will yield substantial gains. As I've argued, that all depends on the environment we're heading into and right now, we simply do not know if deflation, inflation or something in between will prevail. Also, keep in mind what the Chief Actuary of Canada said about the assets now representing four times the benefits, as opposed to ten years ago when they just represented two times the benefits.

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