Wednesday, August 21, 2013

How OTPP Got in Bed With Saks?

Tara Perkins of the Globe and Mail reports, How the Ontario Teachers’ Pension Plan got in bed with Saks:
The job ad might read something like this: Wanted, a serial dater who likes to shop and is familiar with luxury brands.

The relatively small team within the Ontario Teachers’ Pension Plan that struck the deal to invest $500-million (U.S.) in Hudson’s Bay Co., enabling it to pay for its pending takeover of Saks Inc., plays an increasingly important role in the pension plan’s investment strategy.

It’s called the “relationship investing” group, and its head, Bill Royan, likens the job to playing the field in the singles scene. The people on his team – currently fewer than 10 – travel widely, getting to know entrepreneurs, sovereign wealth funds, billionaires and other investors the group might want to do deals with. “Really, it’s like a relationship, and not every dating situation results in a marriage,” Mr. Royan says.

Of late, the team has been spending a lot of time in the luxury brands space. A big part of the reason for that is Michael Kors.

Mr. Royan spent a lot of time a few years back getting to know the individuals that had been helping Mr. Kors, a fashion designer based in New York, build his brand. Among them were two major investors, Canadian Lawrence Stroll and Hong Kong’s Silas Chou, who had been behind the success of Tommy Hilfiger’s brand in the 1990s. (Mr. Hilfiger, who would meet Mr. Stroll at the latter’s home in Westmount, has referred to him as “one of the smartest business guys I’ve ever met,” and said that “he taught us how to think big.”)

Mr. Royan was sold. In the summer of 2011, Teachers’ relationship investing group quietly bought a stake in Michael Kors Holdings, which sells high-end clothes, shoes and accessories, for about $12 a share. About six months later when the company went public on the New York Stock Exchange, Teachers owned about 7 per cent of it. The stock listed at $20 per share, and rose by about 100 per cent in its first year of trading. Its success pushed Canada’s Mr. Stroll onto Forbes’ list of billionaires. Teachers has been selling down part of its stake in Michael Kors to manage the size of its holding, because otherwise it would have more than $1-billion in the company. It’s still the company’s ninth-largest shareholder, with a stake worth more than $350-million.

“One of the challenges that we face as an investor is finding thematic investments which have attractive growth in periods of low interest rates and low economic growth,” says Mr. Royan, who joined Teachers in 2008 from Lehman Brothers in New York. “And clearly, luxury is one.”

“It’s not just in Canada, it’s not just in the U.S., it really is a global phenomenon as everyone hopes that their income rises, whether that’s China, India, Latin America, or wherever,” Mr. Royan says. “People want to have higher incomes. They move to the city, they actually work harder, or everyone in the family works, and as a result their disposable income rises. I travel a lot and every restaurant, every bar, every airport plays the same music. Fashion, brands, music – the globalization theme means that many many people around the world all aspire to the same outcome, and that’s a Michael Kors purse. So from a growth theme, luxury is a very interesting investment.”

Teachers’ relationship investing group specializes in being a minority shareholder, and tends to keep the investments it makes for about four or five years. The “dating” is so important because it has to trust the individuals it’s working with since it doesn’t have the power of a majority owner. Teachers is not trying to dramatically change its partners, but to help them be better.

“We try to add value in concentrated areas,” Mr. Royan says. “Strategy is one. Managing growth. Michael Kors is probably three or four times larger in revenues than it was two or three years ago. How do you hire people? How do you ensure that you can produce purses on time with quality? Marketing … We really focus on a handful of attributes that we think really makes the company much better, rather than micromanaging.”

If HBC’s $2.4-billion deal for Saks goes through as expected, Teachers will wind up owning about 18 per cent of the company. There are long ties between Teachers and HBC, because Teachers’ real estate arm, Cadillac Fairview, is the landlord for a number of Bay locations. In essence, the two had likely already been dating for years. And the lure of Saks, a luxury retailer, fits with the group’s strategy.

Mr. Royan says his team frequently has stretches when it works around the clock to get deals done, and has to be ready to pounce on opportunities that come together quickly. And sometimes, for a variety of reasons, the blood, sweat and tears end without an investment or deal.

“The challenge with structured investments is, like Hudson’s Bay, reaching an agreement with Hudson’s Bay itself is a challenge, and then having Hudson’s Bay win the M&A dynamic for Saks – you actually have to win and win and win and win to have a successful investment,” Mr. Royan says.

Hong Kong’s Chow Tai Fook Jewellery Co. is another company that Mr. Royan’s group invested in. Teachers just opened an office in Hong Kong, where Mr. Royan’s team already has one person and will be adding three more, to continue developing new relationships in that region.
A well known Canadian hedge fund also jumped in on this deal. Arleen Jacobius of Pensions & Investments reports, Ontario Teachers, West Face Capital help finance $2.9 billion acquisition of Saks:
Ontario Teachers' Pension Plan is investing US$500 million and activist investment manager West Face Capital is investing $250 million in the $2.9 billion purchase of Saks Inc. by Hudson's Bay Co., confirmed Deborah Allan, director, communications and media relations for the Toronto-based pension plan.

In exchange for its commitment, the C$129.5 billion (US$125.9 billion) Ontario Teachers plan will receive 1.5 million share purchase warrants when the merger agreement is signed and an additional 3.5 million share purchase warrants when the transaction is closed. West Face will receive 1.75 million share purchase warrants upon closing of the transaction. The exercise price of the warrants and the subscription price of the common shares will be C$17 per share. Hudson's Bay has received conditional approval to issue shares on the Toronto Stock Exchange for OTPP and West Face. The transaction is subject to a 40-day go-shop period during which Saks can solicit other offers.

Ontario Teachers' Pension Plan considers the investment a public equity transaction with “strong monetization opportunities,” Ms. Allen wrote in an e-mailed response to questions.

According to an Ontario Teachers news release Monday, the deal creates a coast-to-coast North American retail portfolio serving three retail brands: Saks, Lord & Taylor and Hudson's Bay. Hudson's Bay expects to eventually realize “substantial value” from the combined real estate portfolio, possibly through creating a real estate investment trust.

“We see this deal as an excellent and rare retail investment opportunity and one that offers great synergies to the companies involved,” Ms Allen stated. “It's a classic OTPP investment, which partners with a leading industry player to dramatically transform a company, and which demonstrates all of OTPP's strengths as a leading, long-term investor. We're very excited to be involved in such a dynamic transaction involving such historied and iconic brands.”

Hudson's Bay is owned by Purchase, N.Y.-based NRDC Equity Partners.
Relationship investing is an increasingly important activity at Ontario Teachers' Pension Plan. Details on OTPP's approach to relationship investing are provided on their website:
Relationships That Deliver Growth Through Partnership

For more than a decade, our strategy of purchasing large equity stakes (between 2% and 30%) in public companies — or companies about to go public — and partnering with leading management teams to improve shareholder value has delivered above-market performance for the plan.

Our multi-year perspective enables our partner companies to focus on long-term business strategies and opportunities, not on short-term results.

Our Relationship Investing team has the knowledge, experience and financial backing to complete large, sophisticated deals and to effectively partner directly with public companies in long-term relationships.

Whether we're partnering with industry leaders, supporting a major change in corporate strategy or helping a company improve its business and financial performance, our Relationship Investing group works constructively with boards and senior management teams in Canada and around the world.
How We Invest

Our investments are large — $200 million and up - and the typical hold period is five to seven years. This long term or "patient capital" view matches Teachers' long-term obligations to pay pensions, and enables management teams to concentrate on improving long-term shareholder value.

For investee companies, we offer:
  • strong, established partnerships, including a global network of industry and financial contacts who know our reputation and track record
  • sophisticated skill sets on the Relationship Investing deal team, plus the broader resources of our fixed income, infrastructure, private and public equities groups
  • the ability to structure investments to meet the needs of unique situations
  • significant liquidity and size, providing the financial firepower needed for large equity investments
  • more than a decade of experience working closely with partner companies
  • a long-term investing horizon

Our work includes:
  • partnering with industry — we invest in assets alongside premier companies
  • solution investments — we support a major change in a company's strategy
  • constructive activism — we encourage boards and management to improve business and financial performance
In each situation, we see our involvement as a catalyst. By helping companies to establish themselves, grow through acquisitions, reduce debt and undertake major capital programs, we have been instrumental in transforming entire sectors, such as the Canadian coal industry.

Teachers' Relationship Investing is different because:
  • We run a concentrated portfolio, more akin to private equity than traditional public equities
  • Our holdings are generally more liquid than private equity, but less liquid than publicly traded stocks
  • We have more influence with our partner companies than investors in widely held public companies do, but less control than private equity investors typically require
  • We conduct heavy due diligence, similar to private equity investors
  • We can act quickly on appropriate transactions
The success of relationship investing at OTPP has prompted other large Canadian pension funds to start their own relationship investing groups but Teachers is way ahead of the curve. This is yet another example of how big investors are dodging Wall Street, taking a sizable but minority stake in companies and working closely with boards and management to improve business and financial performance.

Relationship investing is not a new concept. In fact, Bloomberg published an article back in 1993, citing the advantages of this approach:
To backers, relationship investing has two charms. First, it helps solve a problem executives have complained about for years: short-term investing. By creating a class of enlightened investors who give companies patient capital, relationship investing should free management to focus on the long term. Over time, that should lift profits, productivity, and prospects. And that would boost U.S. competitiveness.

Second, the very existence of a new breed of active capitalists fixes another failing of U.S. corporations: the imperial CEO, unchecked by a pliant board of directors. "In the U.S., we have the George Patton model of governance--one person with all the authority," says SEC Chairman Richard C. Breeden. "It works great if the person is Sam Walton--a person with the vision and the skills to do the job. But you're vulnerable to an all-powerful dud." Investors who actively monitor their holdings would introduce a badly needed measure of management accountability.

Those two virtues--patience and accountability--are more common in governance systems outside the U.S. In Japan and Germany, for instance, banks or companies take permanent stakes--and put representatives on the board. With no need to worry about quarterly results, management can make investments that may not pay off for years. But those systems have other drawbacks: Individual shareholders have few rights, entrepreneurs can't easily raise capital, and managers invest wastefully.
But for all the past hoopla on relationship investing in the U.S., it really has not taken off in a meaningful way. One big reason is that U.S. public pension funds don't have the governance, knowledge and experience of their Canadian counterparts to carry out this activity properly.

There is another reason. Relationship investing isn't easy and the success of this approach at large Canadian funds varies. Even Teachers' has had setbacks but they scored huge on Michael Kors, smartly betting on  Lawrence Stroll and Silas Chou, the two entrepreneurs behind the success of Tommy Hilfiger’s brand in the 1990s.

Will HBC's acquisition of Saks be another winner for OTPP? Maybe but it won't be another Michael Kors, that's for sure. Saks has been struggling lately, reporting a larger-than-expected second-quarter loss on Monday after disappointing sales of shoes and handbags forced it to reduce prices.

The problem, however, isn't Saks' short-term woes but rather HBC and what they can bring to the table. My industry contacts tell me HBC is a "terribly managed company," which if true, doesn't bode well for Saks or OTPP.

One thing is for sure, Bill Royan and his small team have their work cut out for them. I'm sure they're already busy on their next relationships, looking at where they can add value to OTPP's portfolio.

Below, Gilbert Harrison, founder and chairman of Financo Inc., talks about Hudson’s Bay Co. agreement to buy New York-based Saks Inc. for $2.4 billion and the outlook for the luxury consumer goods market. Harrison speaks with Sara Eisen and Erik Schatzker on Bloomberg Television’s “Market Makers.”