Building a first for Canada

D’ARCY JENISH July 27 1987

Building a first for Canada

D’ARCY JENISH July 27 1987

Building a first for Canada

When Toronto-based Onex Corp. went public in April, president and chief executive officer Gerald Schwartz conducted his own high-energy sales campaign rather than relying entirely on the underwriters. He personally lobbied Canadian institutional investors for buy-orders and flew to Europe for meetings with potential investors. His efforts, combined with

the company’s reputation as a specialist in leveraged buyouts—in effect, a method of buying a company with its own assets—made Onex one of the hottest Canadian issues of the year. In less than a month the company raised $246 million—well over original expectations of $150 million—and started to put the money to work. It recently acquired a Canadian leasing company owned by Citicorp, the huge New York-based bank, for $270 million. Now, Onex is on the lookout for other potential purchases, and Schwartz said last week that Onex intends to spend the balance acquiring companies over the next three years.

Although leveraged buyouts are widely used in the United States,

Schwartz is the first Canadian businessman to build his entire company around the technique and the first in Canada to go public with it. Since launching Onex in late 1983, Schwartz and five associates have executed four major takeovers, giving his company assets of about $1.6 billion and more than 13,000 employees across North America. Besides the Citicorp subsidiary, Onex has purchased To-

ronto-based American Can Canada Inc.; Sky Chefs Inc., the third-largest airline catering company in North America; and Purolator Courier Ltd., Canada’s largest courier company.

As Canada’s biggest leveraged buyout company, Onex uses largely borrowed money to take over other firms. Then it places the debt on the books of the acquired company and pays it off with cash flow and profits, or by selling off some of the firm’s assets. Schwartz and his tiny management group have developed a business strategy that allows them to run a sprawling and growing empire. They will pursue only a financially healthy company that is receptive to a takeover, and, as well, they try to retain the previous manage-

ment teams to run the companies.

As a leveraged buyout specialist, Onex occupies a peculiar niche in the marketplace. Harold Wolkin, a senior investment analyst with the securities firm Nesbitt Thomson Deacon Inc. in Toronto, said that Onex looks for long-term investments in healthy companies at the right price. It attempts to increase the value of the acquired firms through better use of assets and by giving management an ownership position. Wolkin added that Onex cannot be accused of greenmailing, a popular practice among U.S. corporate raiders. In essence, the greenmailing raider launches an unfriendly takeover, drives up the price of the target company’s stock and then dumps the stock for a quick profit. Nor is Onex a merchant banker that takes an equity position in troubled companies, provides managerial expertise and then sells out at a profit after a turnaround.

When Onex acquired American Can, since renamed Onex Packaging Inc., in November, 1984, for $253 million, Onex put up only $13.6 million itself. The potential debt load was reduced through a $55-million public share offering and by selling part of the company to its existing management. In the same way, Onex purchased Sky Chefs for $213 million in May, 1986, while investing only $32.6 million itself. But the resulting debt was covered by the sale of Sky Chef’s airport concessions division. In the case of Purolator, Onex paid $253 million, including $45 million of its own money, for 65 per cent of the courier company. The other 35 per cent was sold to the company’s management and outside investors.

Although Onex has achieved its reputation as a buyer, rather than a builder of companies, Schwartz insists that he is more than an acquisitor on a shopping spree. He added, “We take assets out of very stale, stodgy hands and put them into much more dynamic hands that will permit the business to grow and flower and flourish.”

Under his direction, Onex Packaging has spent $125 million on new plants and technology since early 1985, and Schwartz predicts that annual revenues will reach $440 million this year, compared with $328 million in 1984. Said Schwartz: “It’s like creating a new $100-million-a-year company. There are acquisitions which add exactly nothing of value to the country. They simply change the ownership from one set of hands to another.” Onex is attempting to create new jobs and additional wealth, Schwartz said. And he added, “We should certainly be able to buy companies with a total purchase price of over $1 billion.”

Before forming Onex, Winnipeg native Schwartz, now 45, practised law, taught a graduate-level course in mergers and acquisitions at New York University and worked for a Wall Street investment banking firm, Bear,

Stearns & Co. In 1976 he teamed up with Winnipeg entrepreneur I. H. (Izzy) Asper to launch CanWest Capital Corp., which acquired established companies, provided venture capital for promising firms and devised rescue plans for troubled ones. Although they had agreed to a 10-year partnership, Schwartz and Asper parted in 1983 because of personal friction and pressures from their shareholders.

Schwartz then formed Onex with $51.5 million in start-up capital largely provided by former CanWest shareholders.

Throughout the rapid growth of Onex, Schwartz has retained a 60per-cent controlling interest, with the blessing of some of his major institutional investors. Said George Engman, a pension-fund manager and an Onex director with a major stake in Onex: “The concept right from the beginning was that he was the guy we were backing.” Schwartz owns all 100,000 so-called multiple-voting shares issued by the company. Under the Onex bylaws, the holders of the multiple-voting shares are allowed to elect 60 per cent of the company’s board of directors.

By comparison, the purchasers of the 12 million subordinated voting shares issued in April can elect only 40 per cent of the board. If Schwartz leaves the company for any reason, his multiple-voting powers end and holders of the subordinated shares get all the votes. Said Engman: “We wouldn’t like to see a hostile takeover of the company. That was one way of preventing it from happening.”

Besides retaining voting control, Schwartz has rewarded himself and his executives with a generous stock-

dividend plan that will make them millionaires many times over. It provides for an annual dividend equivalent to 20 per cent of any increase in the net asset value of the company. Two-thirds of the dividend is payable to Schwartz and the remainder to his five colleagues. One former Schwartz associate described the arrangement as “extraordinarily rich.” But Eng-

man insisted that the package is typical of leveraged buyout companies in the United States. He added, “In the venture-capital area there are a lot of them in the United States and Canada that provide for a 2.5-per-cent

management fee and 20 per cent of the profit.”

Despite its successful string of acquisitions and the sold-out share offering, the Onex stock has been a disappointment to investors so far. The stock was issued at $20.50 but has been trading in the $15-to-$16 range. Schwartz said that he is surprised and embarrassed by the performance of the shares, and attributes the fall to several problems. Because Onex was a hot issue, institutional investors overpurchased in anticipation of a rapid rise of the price of the Onex shares and quick profits if they sold their excess stock.

Instead, the price started falling and the institutions swamped the market, which drove the price down even further. Schwartz said that most of the major institutional investors in the country participated in the initial offering, which meant there were very few available new buyers once the stock began trading publicly. At the same time, the stock market itself softened immediately after the issue, although it has since recovered. Finally, stagnant sales and profits at Onex Packaging have cooled off investor interest in the parent company, said Schwartz.

But institutional investors who have backed Onex from the start view the falling share prices as a temporary setback. Indeed, most say that they have been pleased with the past performance of the companies to date, and expect healthy returns in the future. Said one portfolio manager: “The price of the stock has come off a bit, but I don’t think it’s a longterm problem.” In fact, Onex is now rich in money and is bringing its most recent acquisitions, Purolator and Citibank Leasing Canada Ltd., up to speed. Schwartz said that he will be looking for further purchases once Onex has digested its new assets. Given its past success rate, and its $160million war chest, Onex shareholders can likely look forward to owning a piece of a much larger, more diverse company in two or three years’ time.