Peloton's Differentiated Approach

During my recent trip to Toronto, I met Mike Murray, a former Managing Director at Ontario Teachers’ Pension Plan and founder of Peloton Capital Management, a new Canadian private equity firm with a long-term approach to middle-market buyouts in North America.

This morning I had a chance to speak with Mike about Peloton but before I get to that, a little background on the fund (November 2018):

Peloton Capital Management, a Canadian private equity (PE) firm with a long-term approach to middle-market buyouts in the North American market, launched today. Unlike many middle-market PE firms that take a short-term (3 to 5 years), generalist approach to investing, Peloton aims to differentiate itself through its long-term capital and orientation (8 to 12-year investment horizon); deep sector expertise and focus on financial services, health care, and consumer markets; and relationships-first philosophy.

Founding Managing Partners Steve Faraone and Mike Murray have extensive PE experience, including their most recent roles as Managing Directors at Ontario Teachers’ Pension Plan (OTPP), one of Canada’s largest pension funds. Faraone and Murray worked together for more than a decade at OTPP where they played key roles in the development of the firm’s direct private equity program, were members of the firm’s investment committee, and held responsibility for three of the firm’s six target industry verticals.

Faraone and Murray are launching Peloton in partnership with Stephen Smith, Chairman, CEO, and co-founder of Canada’s largest non-bank mortgage originator, First National Financial Corporation, and benefactor of the Smith School of Business at Queen’s University. Together, the partners aim to build a leading Canadian alternative asset manager.

Commitments to the Peloton Middle-market Buyout Fund

Smith, who has taken on the role of Chairman of Peloton, has made an anchor commitment of at least C$150MM in the firm’s first middle-market buyout fund. Bank of Montreal, CIBC, Royal Bank of Canada, and TD Bank Group also intend to make commitments to the fund.

“Our vision is to establish Peloton as a leading Canadian private equity firm,” says Smith. “I’ve worked closely with Steve and Mike for almost a decade and am confident in their investment abilities and the potential for generating long-term, sustainable returns.”

Peloton aims to build a concentrated portfolio of 7 – 10 platform investments from its first fund. The fund will focus on well-established, profitable companies that have $10MM to $40MM of EBITDA and present compelling opportunities to build long-term, sustainable value. Individual investments held by the fund will range from $25MM to $75MM.

Faraone and Murray are aligned in the opportunity they see for Peloton, and the approach they will use to drive the firm’s long-term success. “At Peloton’s core is a culture based on the belief that effective collaboration produces better outcomes,” says Faraone. “We will embrace the same relationships-first philosophy that has been the cornerstone of our success throughout each of our careers.”

“We believe there is a need in the North American PE middle-market for a long-term, sector-focused alternative,” says Murray. “While the fundraising market is competitive and there is a lot of capital chasing deals, the opportunity is significant as we are addressing a white space with our unique approach.”

Advisory Board to be Chaired by Jim Leech

Recognizing the important role that Peloton will play in expanding the Canadian PE community, Jim Leech, Chancellor of Queen’s University and former CEO of Ontario Teachers’ Pension Plan, is taking on the role of Chair of Peloton’s Advisory Board.

About Peloton Capital Management

Peloton Capital Management is a private equity (PE) firm that uses a long-term investment philosophy and sector-focused strategy in building a portfolio of North American companies that present compelling opportunities for value creation. Headquartered in Toronto, the company is led by a blue-chip team of partners with extensive private equity experience. For more information please visit: pelotoncapitalmanagement.com.

Interestingly, last night, Jim Leech emailed me to ask me if I was aware Claude Lamoureux was inducted to the Canadian Business Hall of Fame.

I wasn't aware of this but told him I am looking to get in touch with Claude to write a comment on his thoughts on the evolution of the Canadian model as he was the pioneer in Canada who started it all.

It's also interesting that along with Claude Lamoureux, the other inductees to the Canadian Business Hall of Fame include:

• Chief Clarence Louie O.C., First Nations leader, Chief of the Osoyoos Indian Band
• Stephen J.R. Smith, Chairman & CEO, First National Financial
• Annette Verschuren, Chair & CEO, NRStor Inc.

Stephen Smith is a very accomplished businessman, one of Canada’s leading financial services entrepreneurs, and the Chairman, Chief Executive Officer and Co-Founder of First National Financial Corporation.

The fact that he backed Steve Faraone and Mike Murray and founded Peloton Capital Management alongside them and that their former boss, Jim Leech, sits on the advisory board, lends enormous credibility to this fund. That's also why some of Canada's big banks made commitments to the fund.

It's clear that Mike and Steve are experts in the mid-market PE space in North America. Their long investment horizon, deep sector expertise focusing on financial services, health care, and consumer markets and relationships-first philosophy are all key differentiators.

They both worked as Managing Directors at Teachers' Private Capital which explains why they prefer a long-term focus and filling a gap in the mid-market space.

They are not the first to depart Ontario Teachers' to start their own private equity firm. Erol Uzumeri is one of the founders of Searchlight Capital Partners, a very successful private equity fund with offices in New York, London and Toronto.

Anyway, let me get to my call with Mike Murray.

I began by asking him why he and Steve Faraone started Peloton. He told me there was a personal entrepreneurial ambition component but more importantly, they wanted to make sure they're differentiating themselves and addressing an important gap in the mid-market space which isn't being properly addressed.

"There are a lot of great funds out there but few have a long investment horizon, deep sector expertise, and a relationships-first philosophy. What we did at Teachers' led to our long-term success and we wanted to bring that same approach to the mid-market space."

Mike told me the typical private equity fund has a three to five year holding period which isn't always optimal for investors and the management teams of the underlying companies.

"PE funds are often forced to sell winners. At Teachers', we would often see a buyout fund hold an underlying company for three years, make 3X their money, sell it to another buyout fund which holds it for another three years, makes 3X their money, etc. This introduces a tremendous amount of friction costs to investors and distracts management of the underlying company. Our approach eliminates friction costs and extends compounding to generate superior long-term results."

This is one reason why at Teachers', when the PE fund was exiting an investment, they would sometimes look at holding an underlying company longer on their books if they liked it and saw more value ahead.

Mike gave me the public example of when Teachers' Private Capital acquired an additional equity stake in Shearer’s Snacks from Wind Point Partners, allowing Teachers’ to hold a significant majority ownership in Shearer’s, with company management remaining a meaningful shareholder.

He also told me in Bain's latest annual private equity report, which is excellent, there's a discussion on why GPs are launching funds with longer investment time frames, a trend that accelerated in 2018 with large long-duration funds from firms like KKR, Partners Group and CVC (click on image below):

This corner of the PE universe is still relatively small and untested. But it is growing steadily as investors come to appreciate its virtues—lower transaction costs, advantaged tax treatment, more flexibility to sell when the time is right, and capital that is fully invested over longer periods.

But while the large private equity funds are discovering the virtues of Warren Buffett's approach, very few funds are implementing it and even fewer are taking this approach in the mid-market space.

Peloton's long-term focus is a pillar to its approach in the middle market which according to Mike is "a lot more attractive and there isn't another fund taking this long-term approach." He also told me this long-term approach helps them source deals because "it puts management at ease that they have a long-term commitment from their partner."

Another equally important pillar to Peloton's approach is its deep sector expertise. Mike told me while the fund is broadly focusing on financial services, health care, and consumer markets, its real expertise is in sub-sectors of these broad sectors.

Some of the industries they are focusing on include insurance underwriting, distribution and services (particularly P&C), consumer and commercial mortgage finance, clinic and facility-based healthcare services, and branded consumer products.

They are proactive in sourcing their deals, going to industry conferences, meeting with companies looking for capital and getting the right alignment of interests and governance so they can execute a long-term value creation plan.

He told me they have done minority deals but are "active minority partners" always ensuring they have the right alignment of interests so they have the ability to affect the future. "If we do a minority deal, we want to be a significant minority, have co-control and be the second largest shareholder not far behind the founder."

In terms of their size, they are writing tickets of $25 to $75 million and will remain disciplined and focused on the mid-market space."While the rivalry for PE investments is high overall, we believe firmly that the middle market has relatively less competition. This is particularly the case in Canada where the number of Canadian middle market funds has been declining in recent years as firms that had formerly targeted this segment have moved up market."

In terms of a direct competitor, he mentioned Imperial Capital which is similar in size and scope to Peloton, has had good success, particularly in healthcare.

Mike thinks a generalist approach in private equity will not likely lead to long-term success which is why Peloton remains focused and committed to a sectoral approach where they can add value over the long run.

"Peloton's sector-focused approach and deep-dive sourcing strategy differentiates us from generalist firms in the eyes of intermediaries and management teams. It also allows us to leverage our resources effectively by knowing which sale processes to avoid and which ones to have conviction around."

Interestingly, we ended our discussion by discussing trends in private equity. I told him there's a concern over record dry powder, increased competition leading to historically high valuations, and yet so far, it's another banner year for fundraising, especially for the mega funds.

Mike chuckled and again referred to the Bain Global Private Equity Report which shines a spotlight on the significant amount of dry powder available to PE funds, the intense competition for high-quality assets and the lofty valuations being seen in the market.

In spite of these trends, the private equity industry is forecasted to continue to generate strong returns and investors have signaled their intent to maintain or increase their allocations to PE funds in the coming years.

Mike believes private markets will continue to be the place where investors will find alpha but the challenging environment requires a differentiated approach.

I agreed and said just like most active managers are underperforming in public markets, there will be a shakeout in private markets and those who aren't offering the right approach will not survive.

Let me end by thanking Mike for taking the time to talk to me about Peloton Capital Management. I really enjoyed speaking to him today as I enjoyed speaking with George Rossolatos yesterday on the Canadian Business Growth Fund.

Below, Steve Faraone, managing partner at Peloton Capital Management, joins BNN Bloomberg to discuss the new private equity firm he's launched with a long-term approach.

And Mike Murray joins Mark Satov to discuss the launch of his new fund, Peloton. He talks about Peloton’s points of differentiation and shares his views on the state of private equity in North America today. Super smart and nice guy, listen to his insights.