Onex's strategy for quiet Buyout markets

The normal course issuer bid isn’t all that novel, but when a buyout firm does it, you have to take notice. Lest we forget, all that a buyout firm has to live on is its “dry powder”. That undeployed cash horde that has not yet found a home. Merchant bankers can’t show up at Honeywell or Kodak or Boeing and say, “Hi, we want to buy a division, we just don’t have enough scratch right now”.

A few weeks ago a senior Onex (OCX:TSX) operative told a Toronto buyout conference audience that he thought that the debt markets would be tough for the rest of the year. Which meant for a quieter buyout universe. Onex has seen its stock drop 15% over the past six months, and shareholders will be comforted to hear that the firm has ramped up its share buyback program. Comforted to a point.

In 2007, Onex repurchased 3.35 million shares at an average price of $33.80. The stock closed at $30.97 today. About $10 million of shareholder value was burned on this effort, although who knows how far the stock price would have dropped had the company not been playing on the bid side.

This from GMP Securities’ Research team:

“SEDI FILINGS INDICATE THAT OCX CONTINUES TO REPURCHASE STOCK

January 2008 data provided by the System for Electronic Disclosure by Insiders (SEDI) indicates that OCX continues to actively repurchase its stock. Based on the filings, for January 2008 OCX repurchased 1,375,900 shares at an average price of $31.55/share. To put this in context, for 2007 OCX repurchased 3.35mm shares at an average price of $33.80/share and in 2006 the company repurchased 9.2mm shares at an average price of $22.00/share. Stated somewhat differently, the buyback activity in January 2008 equated to about one-third of the total number of shares repurchased in 2007.

WE BELIEVE BUYBACK ACTIVITY IS INDICATIVE OF VALUE AND ON-GOING GROWTH OF MANAGEMENT BUSINESS

We believe the on-going buyback activity is indicative of the value that OCX offers at current levels as well as the upside associated with its third party management business. We currently estimate the OCX NAV to be $37.70/share. This is the value of the investments that OCX owns taken at either market or book value. The one exception to this is Sitel Worldwide, which we value at 8x F07 EBITDA of US$170mm. At current levels the stock is trading at a discount to its net asset value with no value being attributed to the management business.

With respect to the management business, we continue to believe that OCX Partners 3 – OCX’s next fund, is on-track to close in 2008. Specifically, we expect that OCX 3 will be a $4.5 billion fund, with OCX contributing $1.0b. With respect to timing, we expect that a first closing of the fund will likely occur in Q2/08, with a final close happening in H2/08. Although OCX will not receive management fees from OCX 3 until OCX 2 is fully invested, we do not view this as being an unrealistic scenario as OCX 2 is currently 78% invested and has to deploy an additional $735mm of equity prior to being fully invested.

To put this in context, the acquisition of Husky Injection Molding consumed about $600mm of equity. In rough terms then, OCX 2 is one Husky sized transaction away from being fully invested.

MAINTAINING BUY RATING; $48.25/SHARE TARGET PRICE

Our current OCX target is $48.25/share. This valuation represents the sum of the NAV and the
value of the management business. With respect to the management business, we are using a 20x P/E to value the earnings that would accrue to OCX at the time that OCX 2 is fully invested and OCX 3 is funded and in-place. While some investors might argue that a 20x P/E is excessive, using a 10x P/E, our valuation is $42.40/share – a level that is still significantly higher than the current stock price. Note that comparable companies are trading at around 13x’s earnings. As such, we continue to rate OCX as a BUY.”

MRM