Wednesday, November 11, 2015

PSP Investments' Global Expansion?

Chris Witkowsky of PE Hub reports, Canada’s PSP Investments opens NY office for private debt:
Another massive Canadian pension is making a move into the U.S. to directly compete with GPs.

The Public Sector Pension Investment Board, with $112 billion under management, formed PSP Investments Holdings USA LLC, a New York-based private debt investment group. The New York office, at 450 Lexington Avenue, is PSP’s first foreign office.

The group is expected to initially focus on private credit and debt, but will eventually include a small team for private investments, PSP said in a statement.

The private debt group is led by David Scudellari, who recently joined PSP’s U.S. affiliate as senior vice president, head of principal debt and credit investments of PSP Investments. Scudellari has held leadership roles at Goldman Sachs and Barclays Capital, where he was global head of finance and risk — Canada for Barclays in New York.

Scudellari is joined by Ziv Ehrenfeld, senior director, principal debt and credit investments. Prior to PSP, Ehrenfeld was a member of the leveraged finance group at Barclays focusing on natural resources.

“The leveraged finance landscape is currently in transition. With traditional capital providers having lost significant market share in the last few years, there is an attractive opportunity for a long-term investor such as PSP Investments to enter this trillion-dollar plus asset class through its U.S. affiliate,” said André Bourbonnais, president and chief executive officer of PSP Investments.
Scott Deveau of Bloomberg also reports, Canada's Public Sector Pension Names Scudellari for Debt Unit:
The Public Sector Pension Investment Board, one of Canada’s largest pension plans, has appointed David Scudellari to head a new unit focused on debt and credit investments.

Scudellari will lead PSP Investments Holding USA LLC, based in New York and help build up the firm’s presence in more illiquid and alternative debt securities. He has more than 30 years experience in capital markets, including positions at Barclays Capital Inc. and Goldman Sachs Group Inc., according to a statement from PSP.

“The leveraged finance landscape is currently in transition," said Andre Bourbonnais, PSP chief executive officer in a statement. "With traditional capital providers having lost significant market share in the last few years, there is an attractive opportunity for a long-term investors such as PSP Investments to enter this trillion-dollar-plus asset class.”

PSP, which oversees the retirement savings of federal public servants, including the Canadian Forces and the Royal Canadian Mounted Police, is Canada’s fifth-largest pension plan with C$112 billion ($85 billion) in assets under management.
André Bourbonnais is right, the leveraged finance landscape has drastically changed following the 2008 crisis. Many banks have exited this market but don't be fooled, the competition for leveraged finance talent between banks, hedge funds, private equity funds and now Canada's large public pension funds is fierce.

Still, it's been a bad year for leveraged loans and while U.S. deal activity remains steady, there are many factors impacting the market:
It is always important for individual investors to know what is going on in the market. This year, one notable change in deal activity is the drop in leveraged finance transactions and the significant increase in corporate M&A activity. Deal activity in the U.S. remains steady, but the landscape has changed. Private equity firms and leveraged finance bankers are unable to raise enough capital in the debt markets to fund their acquisitions and larger, cash rich corporations are filling that void. Due to high stock prices and limited organic growth, corporations are engaging in takeovers in an effort to spur greater revenues.
Accordingly, this year has seen lots of M&A and less leveraged loan issuance than previous years. Retail investors, however, can rest assured that these are signs of a health market, relying on liquidity rather than risk debt issuance.

A disappointing year for leveraged loans
The leveraged loan market is likely to have one of its weakest years since 2012. Leveraged loans, which are typically issued to fund corporate acquisitions in the middle market have declined because cash-rich corporations are buying up all the opportunities, noted Bloomberg.
Since private equity firms and leveraged finance bankers cannot compete with their larger peers, only $235.1 billion of debt has been sold to institutional investors in 2015 – a 40 percent drop over the previous year. Additionally, only $37.5 billion of leveraged loans have been issued stemming from leveraged buyouts this year, versus $58.4 billion in 2014. It is important to point out that is not necessarily bad news for retail investors, although it is for leveraged finance bankers. William Conway, chief investment officer at private-equity firm Carlyle Group pointed out how M&A has eclipsed leveraged loan activity.

“With corporations struggling to find growth, they have turned to M&A to meet revenue targets while private equity activity has remained relatively muted,” said Conway, noted the media outlet. “It’s clearly an easier time to sell than it is to buy.”

Corporate M&A leads the charge in deal activity
Bloomberg reported while leveraged loan activity is lower than in previous years, total deal activity in the U.S. is strong. There have been many corporate takeovers in 2015 amounting to an impressive $1.09 trillion. In comparison, $45.6 billion was attributed to leveraged buyouts managed by private equity firms this year.

The reason that large corporations are funding so many deals this year is because organic growth has been slow, but stock prices are high, providing lots of liquidity. Companies have lots of cash reserves and need to bolster revenues. Accordingly, these corporations have leaned heavily on acquisitions and takeovers to maintain their growth. Barclays Managing Director of leveraged finance Ben Burton explained that executive officers have been confident in their buying activity this year and that the increased M&A has caused leveraged loan opportunities to dry up.

“We’ve been seeing management teams and their boards more willing to go out and do transformative M&A,” said Burton, according to the news source. “That’s taken supply away from the leveraged-loan market.”

Private equity players are edged aside
In a recent article, The Wall Street Journal described private equity firms as “wallflowers at a global deal-making party,” referring to their inability to generate strong deal activity this year. To clearly illustrate how much leveraged loans are in decline, in 2006, private equity deals represented 19 percent of all deals in the U.S. market. In the time before the credit crisis of 2008, private equity firms like KKR, Carlyle, and Blackstone completed many multi-billion dollar acquisitions, thanks to liberal funding from banks and bond investors. Post financial crisis, new regulations and stricter lending practices have made it more difficult for private equity players and leveraged finance bankers to raise enough money to fund their desired opportunities.

Ultimately, because of new regulations and high stock prices, leveraged loan issuance is on the decline, but this may be a good thing for individual investors. Cash rich corporations engaging in heavy M&A activity is likely to keep valuations high. The Wall Street Journal noted transactions such as Royal Dutch Shell’s $69.8 billion purchase of BG Group and Charter Communications’ $56.8 billion purchase of Time Warner Cable. For the everyday investor, high valuations and low debt levels mean a safer economic landscape to invest in for the long term. Leveraged loans are not a common investment vehicle for the common investor, but shares in publicly traded corporations are. As such, the current situation may provide some comfort to those who wish to see stability in their broad market portfolios.
If you read the article above, you might be wondering why PSP or any Canadian pension fund would want to enter the U.S. leveraged loan market. But unlike private equity funds and banks, Canadian pensions aren't hindered by strict regulations and they have huge funds and a much longer investment horizon than banks, hedge funds and private equity funds.

Moreover, if the Fed does decide to raise rates in December -- a big "if" -- I expect to see a flurry of M&A activity (it's already happening) but this won't last forever. At one point, it will be difficult for companies to finance acquisitions through M&A and that's when leveraged loans will come back in vogue.

As far as PSP, André Bourbonnais is clearly departing from his predecessor's global strategy by opening up offices around the world. He is also departing from his predecessor's strategy of keeping tight lid on all of PSP's deals.

This deal follows CPPIB's acquisition of GE's financing arm and it shows you how Canada's large public pension funds are positioning themselves and how they are setting up foreign subsidiaries to source deals and to properly compensate the talent they need to operate these ventures (guys like Scudellari don't come cheap but it's smarter hiring him than doling out huge fees to PE funds!).

This latest deal follows other global deals PSP has engaged in since Bourbonnais took over the helm in July. Along with the Caisse and CPPIB, PSP is eyeing Indian infrastructure assets. The Australian Financial Review reports PSP Investments is biding for BrisCon's Brisbane tollroad, AirportLinkM7, joining the bidding group headed by Australian infrastructure investor CP2.

What else? ATL Partners, an aerospace and transportation focused private equity firm, is partnering with the PSP Investments to form SKY Leasing:
As part of the transaction, SKY Leasing will acquire certain assets of Sky Holding Company controlled by leasing industry veteran Richard Wiley. Wiley and other key members of SHC management will form the leadership team of SKY Leasing.

“We are very excited to partner with ATL and PSP Investments, two investors with a deep understanding of the commercial aerospace sector,” said Wiley. “We look forward to building a best-in-class lessor with an initial target of $1 billion of Boeing and Airbus aircraft.”

With headquarters in Dublin, Ireland, and ancillary operations in San Francisco, California, SKY Leasing has over $250 million of initial equity capital available to provide sale/lease-back financing solutions globally to commercial airlines seeking to lease young mid-life Boeing and Airbus aircraft. SKY Leasing will also act as servicer to 54 aircraft on behalf of three securitizations.

“We have admired Richard’s prior ventures at SHC, Pegasus and Jackson Square Aviation and are delighted to partner with him and his management team in establishing SKY Leasing,” said Frank Nash, CEO of ATL. “As a sector-focused private equity fund, ATL is mandated to deploy equity capital into the transportation continuum and we see tremendous opportunity in delivering financial solutions to the global commercial fleet.”

“As a long-term investor, PSP Investments views aviation finance as an attractive sector to deploy significant capital in the years ahead,” said Jim Pittman, managing director of Private Equity for PSP Investments. “This investment is consistent with our direct and co-investment strategy to partner with experienced management teams who have the capability to scale investments over time. We look forward to supporting SKY Leasing as it pursues its ambitious growth plans.”
Glad to see Jim Pittman is still around at PSP as he was one of the few good guys I remember from my time there. Derek Murphy, the former head of PSP's Private Equity group and the man who hired Jim, departed PSP shortly after André Bourbonnais took over and was recently replaced by Guthrie Stewart.

Another nice guy who is still around is Neil Cunningham, PSP's Senior Vice President and Global Head of Real Estate Investments. I've openly questioned PSP's ridiculous real estate benchmark when covering PSP's fiscal 2015 results but that has nothing to do with Neil. It was a golden handshake between Gordon Fyfe and Neil's predecessor, André Collin who is now president of Lone Star Funds, that sealed that deal (of course, Neil and the rest of the senior managers at PSP still benefit from this 'legacy' RE benchmark).

Anyways, PSP just formed a joint venture with Aviva Investors to invest in central London real estate:
Under the equal partnership, Aviva Investors’ in-house client Aviva Life & Pensions U.K. has agreed to sell 50% of its stake in a central London real estate portfolio to PSP Investments. Aviva previously owned 100% of the portfolio. The portfolio consists of 14 assets across London, made up of existing real estate or those with planning consent.

Aviva Investors will manage the assets and development for the joint venture.

The spokeswoman for PSP Investments said financial details of the transaction are confidential. The net asset value of PSP Investments’ real estate portfolio as of March 31, was C$14.4 billion ($11.4 billion,) she said.

“This investment is consistent with PSP Investments’ real estate strategy to invest in prime and dynamic city centers that we expect will outperform in the future, and is complementary to PSP Investments’ existing portfolio in London,” said Neil Cunningham, senior vice president, global head of real estate investments at PSP Investments, in a news release from Aviva Investors. Further details were not available by press time.

Aviva Investors has more than £31 billion ($47.8 billion) of real estate assets under management. PSP Investments manages C$112 billion of pension fund assets for Canadian federal public service workers, Canadian Forces, Reserve Force and the Royal Canadian Mounted Police.
I don't know enough details about this deal to state my opinion but I have to wonder why Aviva Investors is looking to unload half its stake and why PSP is buying prime real estate in London at the top of the market (trust me, I know how out of whack London's real estate prices have become).

But Neil isn't a dumb guy, far from it, and I have to take his word that he expects these assets to outperform in the future and that they are complementary to PSP's existing portfolio. I hope so because I'm sure PSP paid top dollar (more like pounds) to acquire these assets.

Below, Sahil Mahtani, analyst at Deutsche Bank, likens the London real estate market to the Hong Kong property bubble and why he says it is about to burst. He speaks with Jonathan Ferro on Bloomberg Television’s “On The Move.”

Lastly, it's Remembrance Day so I embedded a Canadian tribute to the men and women who have served with their nations' armed forces and have sacrificed so much to give us what we have today. PSP Investments manages the pension contributions of Canadian Forces allowing these soldiers to retire in dignity.

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