Ontario Teachers' Eyes New Tack?
Ontario Teachers’ Pension Plan first began to lead the Canadian pension funds’ shift from sleepy, passive investors to globe-trotting deal makers 25 years ago.Ontario Teachers' Private Capital is a success story. Under the watch of Jim Leech, the former CEO, it really took off and blossomed. Jim was the person who hired Mark Wiseman to develop Teachers' private equity fund and co-investment program before he moved on to head CPPIB.
What Teachers started in 1991 with a few million dollars and its first direct private equity investment has grown into a multibillion-dollar private-capital group active around the world. Others have followed, with new funds specializing in buyouts and turnarounds emerging and more institutional investors seeking to boost their exposure to alternative investments.
Now wrapping up a landmark year, Teachers Private Capital is giving more thought to selling some investments into the hot market.
“We’ve probably been more focused on taking advantage of where prices are today and lightening up on some of our holdings than we have been on adding new companies to our portfolio,” says Jane Rowe, head of Teachers Private Capital division, from headquarters perched in northern Toronto.
Ms. Rowe is taking stock of a private-equity portfolio representing 16 per cent of Teachers’ total assets – $28.4-billion as of the end of 2015, the most recent figure available. When the Ontario Teachers’ Pension Plan was made independent in 1990, it was just a pile of non-marketable Province of Ontario debentures. Over time, Teachers Private Capital bought up a quirky range of international businesses such as a British lottery, seniors’ housing facilities, mattress companies and snack foods. In its next act, Ms. Rowe says Teachers Private Capital will further refine how it sets itself apart from – and partners with – its global competitiors.
It has been a profitable run for the country’s largest single-profession pension plan. After factoring in asset management, internal and carried interest costs, the group has generated a 20.2-per-cent internal rate of return for the schoolteachers of Ontario since its inception.
Over time, Teachers Private Capital has sent less money to private-equity firms to invest on its behalf, building a team that can do more direct investments that now make up about three-quarters of its holdings. In many cases, the private equity funds that it does invest in have also become co-investment partners on other deals.
There were some hard lessons along the way. A massive $35-billion leveraged buyout bid for Bell Canada Enterprises (now BCE Inc.) that Teachers led in 2007 might have been the world’s largest at the time, but instead fizzled out 18 months later. And the group’s very first private-equity investment of a 25-per-cent stake in the White Rose Crafts and Nursery Sales Ltd. store chain was a major bust.
“We lost all our money within six months – that’s the folklore,” says Ms. Rowe of that investment. “But shortly thereafter – about two years later – we did our investment into Maple Leaf Sports & Entertainment. And that’s one we held for 17 years,” she says. Teachers’ sold its stake to Canadian telecom giants in 2012 for $1.32-billion.
Twenty years ago, Teachers was already being recognized as a potentially significant source of capital for Canadian mergers and takeovers. But the then-$35-billion pension fund was limited in its investments by the depth of Canada’s capital markets, because federal pension laws capped foreign investments at no more than 20 per cent of the total fund.
While finding its footing in the Canadian private-investment world, Teachers private-capital team encountered criticisms that it didn’t have the knowledge and experience needed to influence corporate management and boards when it took large stakes in companies, or led hostile bids.
Two decades later, Teachers Private Capital has proven its ability to turn companies around at home and abroad – it built up investments in North America, Europe, Asia, Africa and South America and now has about 70 investment professionals. But the group is being tested in other ways. Keeping the international team focused, engaged and committed to Teachers is the challenge Ms. Rowe thinks about most. “I’m always worried somebody’s going to poach them or steal them,” she says.
There’s also a lot more competition out there for Teachers, not only from other Canadian pension funds that have developed their own robust private-equity investment arms, but from investors around the world. The amount of available money piling up with private equity fund managers, called dry powder by industry insiders, hit a record $839-billion (U.S.) globally in September, 2016, according to research firm Preqin. That has grown from a little more than $500-billion a decade ago.
Teachers’ private equity team feels the pressure to prove they can outperform stock indexes that can be bought and managed without the same expense. “You can do that in part through leverage, but really what we kind of say is fundamentally you need to find sectors that you hope are going to outperform GDP over an extended period of time,” Ms. Rowe said.
That’s why Teachers toasted its quarter-century with a $1.03-billion (Canadian) deal for wine-producer Constellation Brands Inc. this fall, giving the pension plan a cellar full of top wine brands such as Kim Crawford and Jackson-Triggs. Teachers’ estimates that Canadian wine consumption is growing at about 4 per cent to 5 per cent annually, compared to a couple of per cent for Canadian GDP.
This deal also recalls Teachers’ earlier investments. In the 1990s, the pension plan took a 23-per-cent stake in wine producer Vincor International Inc. for $13-million – a much smaller cheque size than would turn its head today. Teachers later helped the business leap to the public markets. Vincor was then acquired by Constellation Brands about 10 years ago. Now, it’s returning to the Teachers stable.
The fund does more direct investing than it used to, which has made its relationships with other private-equity investors more important.
“The further you go in geography from home, the more you should probably have a smart friend at the table as you are doing those transactions,” Ms. Rowe said. “If an opportunity came in, for argument’s sake, for Colombia or Korea, you know, I’d be kind of saying what makes a Teachers’ here at Yonge and Finch the go-to provider of capital there?”
As Teachers built its reputation as an investor among other international private equity heavyweights, it has also relied on its wholesome brand. Everyone has been to school and can relate to paying the pensions of hard-working teachers. It’s a tougher sell for private equity firms, which are perceived as making money purely to fatten the pockets of their top brass, Ms. Rowe says. “It’s easier to make why we do our investing resonate.”
And under the watch of Jane Rowe, the current head of Teachers' Private Capital and likely next president of Ontario Teachers', direct investments have continued to be the focus as they try to contain costs and get more bang out of their private equity buck.
But these are treacherous times for private equity, there are serious and legitimate concerns about diminishing returns and misalignment of interests.
Against this backdrop, Canada's new masters of the universe are focusing their attention on other asset classes, like infrastructure where they can invest huge sums directly, foregoing any fees whatsoever to third party funds.
Still, private equity is an important asset class and will remain an important asset class as Canada's large pensions push further into private markets in their constant search for alpha. What this means is that all these large pensions will continue to develop their fund and co-investment programs to try to gain access to larger deals where they effectively pay no fees.
Go back to read my recent comment on whether size matters for PE fund performance. There I discuss the push from OMERS and others to invest more directly in private equity but I also tempered my enthusiasm on direct PE investments noting the following:
While I welcome OPE's success in going direct, OMERS still needs to invest in private equity funds. And some of Canada's largest pensions, like CPPIB, will never go direct in private equity because they don't feel like they can compete with top funds in this space.When I talk about direct investments above, it's purely direct, which means the teams source their own deals and help transform operations at a private company they acquired. I think this is a hard space to compete against giants like Apax, Blackstone, Carlyle, KKR, TPG and others.
[Note: It might help if OPE reports the IRR of their direct operations, net of all expenses relative to the IRR of their fund investments, net of all fees so their stakeholders can understand the pros and cons of going direct in private equity. Here you need to look at a long period.]
There is a lot of misinformation when it comes to Canadian pensions 'going direct' in private equity. Yes, they have a much longer investment horizon than traditional funds which is a competitive advantage, but PE funds are adapting and going longer too and in the end, it will be very hard, if not impossible, for any Canadian pension to compete with top PE funds.
I am not saying there aren't qualified people doing wonderful work investing directly in PE at Canada's large pensions, but the fact is it will be hard for them to match the performance of top PE funds, even after fees and expenses are taken into account.
Who knows, maybe OPE will prove me wrong, but this is a tough environment for private equity and I'm not sure going direct in this asset class is a wise long-term strategy (unlike infrastructure, where most of Canada's large pensions are investing directly).
It's much easier for Canada's large pensions to invest in funds and then invest directly through co-investments (where they pay no fees) on bigger deals or when a large private equity fund sells them a big stake in a private company, like the Apax-CPPIB deal on GlobalLogic I covered in my last comment.
The key point is this, Ontario Teachers, CPPIB, OMERS, PSP, bcIMC, AIMCo, the Caisse and other large Canadian pensions will never be able to compete head on with premiere global private equity funds for two reasons. First, they can't compete on compensation and second they will never get the first phone call from investment bankers or strategics (companies looking to sell a business unit) when there is a great deal on the table.
It's just never going to happen, ever. This doesn't mean that Jane Rowe, Mark Redman, Jim Pittman, Ryan Selwood or other private equity professionals at Canada's large pensions aren't good at what they do. They are damn good at what they do but even they will tell you what I'm telling you is 100% accurate, not in their wildest dreams can they effectively compete with PE giants, even over a very long investment horizon.
When it comes to private equity, there is a symbiotic relationship between Canada's large pensions and large private equity global funds. They need each other to thrive and make the necessary returns they require to justify a 10 or 15% allocation to private equity. Sure, Canada's large pensions are doing more and more direct investments, mostly through co-investments with large PE funds they invest in and pay big fees to. But this notion that Ontario Teachers' Private Capital or any other private equity group at Canada's large pensions will move entirely into direct investments effectively competing with top private equity funds on big deals is pure fantasy. And it's a dangerous notion because it's not in the best interests of their beneficiaries and stakeholders.
Just to underscore this point, Ontario Teachers' recently announced a great deal with Redbird Partners to invest in Dallas-based Compass Datacenters:
RedBird Capital Partners (“RedBird”) and Ontario Teachers’ Pension Plan (“Ontario Teachers’”) today announced an investment in Compass Datacenters, LLC (“Compass” or the “Company”) in partnership with the Company’s management team, which includes Founder and CEO Chris Crosby. The existing management team will continue to lead the business and execute the Company’s growth strategy, which is supported by long-term, flexible capital from Compass’s new investment partners. Financial terms of the transaction were not disclosed.The recent deals of Ontario Teachers' investing in Compass Datacenters and CPPIB buying a big stake in GlobalLogic underscore the need to have great private equity partners all around the world. They also show you where these two mega pensions see growth in the IT sector going forward.
“The next major wave of growth in the data center industry will be driven by the need for dedicated data centers that address technology trends including large-scale Internet of Things deployments, edge computing strategies that reduce latency, rapid delivery of new applications, and more,” said Chris Crosby. “I couldn’t be happier about welcoming RedBird and Ontario Teachers’ to our team, as it provides Compass with the financial resources to fund the next phase of our growth with partners who have deep domain expertise in the industry. We will continue serving as a trusted, behind-the-scenes provider to large-scale users in this multi-billion market which is experiencing impressive double-digit growth.”
Based in Dallas, Texas, Compass is a leading wholesale data center developer, specializing in customized build-to-order solutions for enterprise, cloud computing, and service provider customers. Compass focuses on solving customer needs through its patented architecture, scalable design, low cost of ownership model, and overall speed to market. Compass’s solutions also enable customers to locate their dedicated facilities anywhere. This functionality provides customers with the degree of geographic flexibility necessary as the Internet of Things (IoT) and large rich packet applications (such as video and augmented reality) require data centers to be located closer to end users. Compass CEO Chris Crosby was a founding member of the second-largest data center company in the world and leads a team that has collectively built over $3 billion of data centers globally and operated more than six million square feet of space.
“Compass’s unique solutions align perfectly with the way data center needs are evolving for large cloud/SaaS providers, corporate customers and service providers, and this investment gives Compass significant resources to take advantage of market opportunities,” said Robert Covington, Partner of RedBird Capital. “Compass now has the ability to develop larger, multi-phase projects for customers, as well as to invest in the acquisition of real estate in markets that support customer needs. Compass is one of the great stories in the data center industry, and we are proud to be part of the team’s growth strategy.”
“This investment enables Compass to significantly advance its growth plan, maintain its focus on innovative customer solutions and continue to leverage the experience and knowledge of its talented management team,” said Jane Rowe, Senior Managing Director, Private Capital, Ontario Teachers’. “We recognized that Compass is a leader in its market segment and, through this partnership, is very well positioned to serve as the trusted data center partner for even more customers whose evolving technology needs can be met by the facilities that Compass designs and builds.”
DH Capital served as exclusive financial advisor to Compass Datacenters on the transaction.
Below, Ontario Teachers' Pension Plan President and CEO Ron Mock discusses the challenges facing pension funds in the wake of Brexit and President-Elect Donald Trump's election, and the investment risks from geopolitics. He speaks with Erik Schatzker from the World Economic Forum in Davos, Switzerland on "Bloomberg Markets."
Listen carefully to Ron's comments on geopolitical and tail risks in the markets and how they are preparing for market swings and investing in infrastructure under a Trump administration. He also wisely explains why a bond bear market is not necessarily bad for Ontario Teachers (or a HOOPP) because liabilities will drop if bond yields continue rising. Luckily, I don't believe it's the beginning of the end for long bonds, far from it.
On private equity, he notes the following: "In private equity these days, the premium relative to public markets is very tight. We go private but we pick our spots one asset a time. They are out there, it just means you've got to dig five times harder to find them. Ten years ago, private equity traded a thousand basis points over the S&P 500, today it's 200 basis points and sometimes tighter, so you're not getting much incremental return unless you have a clear plan on how to drive EBITDA growth in a private equity company."
Ron Mock is basically warning all you pension fund managers indiscriminately piling into private equity that returns are going to be much lower going forward and unless you have a clear strategy on expanding EBITDA growth, you're not going to get the big fat premiums of the past in this space.
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