Conflicting signals in public, private debt markets

Depending on your news source, this is either a rosy or horrible time to raise new debt for your mid-large sized company.

The publicly-traded high yield debt market has taken a pasting this summer, with US$20 billion of fund outflows since June. It can’t be a good time to be a borrower with a new debt issue coming to market (from Reuters Breakingviews in London, H/T G&M):

Like an old-fashioned bank run, no one knows for sure what started the run on high-yield funds in July, 2014.

Deutsche Bank has a plausible account. It thinks so-called short-duration funds started to suffer outflows in May, perhaps because they had been particularly richly priced by yield-crazed investors. Then investors started to worry that the U.S. economy would soon be strong enough to support higher policy interest rates, which would make junk less attractive. Janet Yellen turned a jog into a run in July when the Federal Reserve chair said high-yield valuations “appear stretched.”

As the high-yield funds were selling, they ran into a shortage of buyers. Many investors were too worried about Ukraine to want many risky assets. The effect was dramatic. About $20-billion (U.S.) has been withdrawn from high-yield funds since June, Barclays believes, the longest consecutive period of outflows on record. High-yield spreads jumped 55 basis points in a month – with no sign that defaults were rising.

Now, I’d argue that a high yield offering in the range of 5 or 6 percent isn’t really much of a “high yield” per se. It is certainly higher than what government bonds of the same tenor would pay, but that’s not traditionally been a sufficiently attractive selling feature for investors; the rate had to be high on an absolute basis, not just a relative one. For investors who saw implied HY rates quickly back up 55bps though, the mark-to-market loss on the face value of their portfolio HY bonds was real. Even if a new HY issue would still be priced at an attractive rate from an issuers standpoint based upon historical norms.

There are still plenty of high yield issues in the 8% range these days, but, again, this paper is sporting a coupon which is ~300 bps lower than traditional interest rate levels for such issuers — despite the same notional expected rate of default.

It doesn’t make sense to me either.

The problem for issuers isn’t the quick 55bps jump in rates, it’s the fact that US$20 billion of investor capital was redeemed from funds over the past few weeks. The absence of liquidity within institutional and retail funds dedicated to high yield bonds usually serves to brutally shut the door to many new offerings.

In the private debt market, however, AltAssets is reporting that “Leveraged loans in US technology sector hit all-time highs” recently. Frankly, from what our firm has been seeing in 2014, this doesn’t come as a surprise (see prior post “Bloomberg: Regulators stand by while U.S. bank lenders get footloose” May 14-14).

It may strike you as odd that illiquid $20 million – $100 million loans for U.S. private technology companies have never been easier to find, all while the public high yield bond market is in a funk. There are a few reasons why this is happening, and they aren’t very complicated:

- some U.S. specialty banks are making it easier than ever for unprofitable tech firms to get meaningful loans booked, with the tacit support of the FDIC and Federal Reserve (so far)

- some hedge funds have returned to the sector, after fleeing in 2008

- as much as the IPO market has been open to tech names for most
of the past two years, new investment funds have been created to allow higher quality private firms to “Stay Private Longer”. These aren’t the pre-IPO equity vehicles that invested in Facebook or Twitter, which were designed to give some liquidity for shareholders prior to an IPO. This is actually capital destined for the company’s coffers to spend in an effort to grow revenue.

- the fact that these private company loans are illiquid often gives lenders the ability to carry them at more static valuation levels for accounting purposes, unlike publicly-quoted bonds whose notional values bounce around from day-to-day

As much as this might explain-away the current divergence in the two debt markets, it is impossible to predict who will blink first. Institutional lenders, who see two more years of lowish interest rates in the US and Europe, or private debt players (including banks), who might want to be cautious about booking deals today that will only serve to have their own LP investors, regulators and/or shareholders look back in 18 months and say:

“You did what?”

It almost takes me back to 2006-07 (see prior post “US mortgage liquidity crisis at hand” Mar 14-07). Which was soon followed by former Citibank CEO’s famous quote:

In July 2007, Prince told the Financial Times that global liquidity was enormous and only a significant disruptive event could create difficulty in the leveraged buyout market. “As long as the music is playing, you’ve got to get up and dance,” he said. “We’re still dancing.

Market players will never forget how that turned out, right? Right?


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When it comes to marketing at least, Kevin O’Leary knows what he’s doing

News report: Kevin O’Leary leaves CBC, joins CTV

I know that you are probably expecting me to be critical of CTV’s decision to take Kevin O’Leary back, five years after he quit BNN to join Amanda Lang and the CBC. Quite frankly, I just can’t bring myself to do it. It wouldn’t be right, to be honest, as CTV is just displaying the natural tendency that we all have to let a talented marketer convince us to do something that might be against our better judgment. What Mr. O’Leary has taught Canada over the past decade isn’t about business or investing, but how to market yourself to the world in the face of tough odds, and that deserves acknowledgement and applause.

Hat tip. Clap.

Just imagine the challenge that Mr. O’Leary had to keep the “Decade of Daddy” rolling along to his financial satisfaction. The CBC recently lost the TV rights to NHL hockey and is undergoing massive budget cuts as a result. This left little in the kitty to pay KO for his contribution to Ms. Lang’s CBC show; he’s no longer doing these TV gigs solely to sell mutual funds or mortgages, since we know that at least two of Mr. O’Leary’s TV-generated start-ups are not working out as planned (see prior posts “RRSP season unkind to Kevin O’Leary’s fundraising hopes” June 5-13 and “Kevin O’Leary closes failed mortgage startup” Apr 14-14). The lack of budget at CBC put Mr. O’Leary’s agent in a tough spot. His client “gots to get paid.” There aren’t that many doors to knock on in Canada, and he was left to go back to the parent company of BNN (a specialty channel I love), which launched Mr. O’Leary on the unsuspecting Canadian public circa 2005, to see if they’d forgive and forget.

That’s where the salesmanship comes in.

According to CTV’s parent, Bell Media, Mr. O’Leary is a “financial expert.” Now, according to a lot of other media outlets (see The New York Times, Canadian Business Magazine or the ROB Magazine), and not just we backwater bloggers (see prior representative post “Highlights of our Kevin O’Leary Blog Posts” Sept. 27-12), this is, shall we say, debatable.

In its press release, CTV touted Mr. O’Leary’s last real corporate role as evidence of his “strong business acumen”:

Previously, O’Leary founded and was president of SoftKey (later called The Learning Company), a global educational software company, and negotiated its $4 billion acquisition by Mattel.

If you’ve ever seen Mr. O’Leary talk about his time with TLC on television, you likely heard him bark something like “when I sold my company for $4 billion dollars” in the direction of an entrepreneur on Dragon’s Den who thought he knew better than KO himself. We know from the NYT that Mr. O’Leary earned all of about $7 million after tax from that TLC-Mattel transaction, half of which came in the form of severance. Whatever. $7 million is a still lot of money, CTV might say, even if it isn’t $4 billion (see prior post “What is the origin of O’Leary’s “billionaire” moniker?” Jan. 24-10).

The TLC-Mattel story is an odd place to go if CTV is using Mr. O’Leary’s negotiation of the Mattel deal as proof of his “business acumen”. Why, you ask? Because a massive shareholder lawsuit flowed from the same O’Leary negotiation that CTV cites. Mattel shareholders wrote off the entire $4 billion purchase price barely a year after their company acquired TLC, and Mr. O’Leary, among others, was sued in the United States District Court of California for “stock fraud”, amoung other market non-nos:

…making “false statements”, “stock fraud”, “artificial inflation in Mattel’s stock price”, trading “while in possession of and using material non-public information”, “improper revenue recognition”, and financial statement “manipulation”….

Before the case went to trial, Mr. O’Leary, Mattel and his fellow defendants paid US$122 million in 2003 to settle the fraud accusations. Although he never talks about it publicly, and it isn’t mentioned in any of the O’Leary Funds disclosure documents on SEDAR, the producers at CBC’s Redemption Inc. felt the settlement had to be disclosed on that shows’ website as part of Mr. O’Leary’s bio circa 2012.

That was two years ago, which is a lifetime in the television age. And it’s not just Canadian television producers who are susceptible to the art of salesmanship.

If you ever watch CNBC, you’ll have noticed that Mr. O’Leary has become a quasi-regular market commentator of late; when he does double-enders, O’Leary Funds logos float behind his head. No chance is missed to market his fund company, despite its performance (see representative prior post “Shed a tear for O’Leary’s Yield Advantaged Convertible Debenture IPO investors” Mar 24-13). CNBC sees KO on Shark Tank, hears about the $4 billion sale to Mattel, and assumes he’s a business guru.

Which leads to further marketing opportunities. On July 22nd, the CNBC show anchor asked KO what he was doing with “your funds” based upon Mr. O’Leary’s belief that interest rates would be rising sooner than expected. Mr. O’Leary responded:

“I have shortened the duration in my funds” “to 36 months”.

According to the current disclosure documents for O’Leary Funds on SEDAR, such as those dated June 18, 2014, Stanton Asset Management Inc. is the Portfolio Advisor to the O’Leary Funds and “manages the investment portfolio of each of the Funds.” To my knowledge, Mr. O’Leary has no accreditation to actively manage investment capital in any Province in Canada.

As such, there is no way that he is in a position to shorten the duration of the funds being managed by Stanton. Mr. O’Leary is not employed by Stanton, and is never referred to as member of the team performing the Portfolio Advisor role for O’Leary Funds. Quite the contrary, as one recent Prospectus discloses:

“The Portfolio Advisor has also engaged O’Leary to provide consulting services to the Portfolio Advisor in respect of the Portfolio. The Portfolio Advisor, together with O’Leary, will implement the investment strategy of the Portfolio Trust. O’Leary will identify markets and investment opportunities but will not recommend the purchase or sale of specific securities by the Portfolio Trust. The Portfolio Advisor is ultimately responsible for the investment decisions of the Portfolio Trust and will review opportunities identified by O’Leary and make the investment decisions on behalf of the Portfolio Trust.”

You got that?

According to the requirements of Canadian Securities Regulators, Mr. O’Leary can give advice about duration strategy, but Stanton’s team is responsible for the investment decisions of the various funds. That’s not how Mr. O’Leary depicted it on CNBC last month, when he advised retail investors across Canada and the USA that “I have shortened the duration” of “my” bond investments, but those are just petty regulatory details.

For a talented marketer, you just keep on pitching. As Mr. O’Leary has proven, if you keep at it long and hard enough, someone will buy, no matter what.

Every entrepreneur should take heart.

(this post, like all blogs, is an Opinion Piece)

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9% Commercial Loan growth looks good for banks, economy

Published on August 5, 2014 by in Economy

It is so easy to fret about the Canadian economy.

Lacklustre job growth, Ontario’s oppressive government debt, regular plant closings…. And yet, when one looks at the balance sheets of Canadian banks, businesses are actually taking advantage of unusually low interest rates and putting their bank lines to work. Over a twelve month period, net commercial lending to domestic businesses by Canadian chartered banks grew by just over 8.5%, hitting $230 billion.

That’s a collective commercial loan book that’s more than 20% higher than when I starting tracking these Bank of Canada stats in December 2008 (The category is “Business loans to Canadian residents for business purposes”):

December 2008: $191.563 billion
January 2009: $185.679 billion
February: $183.759 billion
March: $184.089 billion
April: $181.811 billion
May: $178.691 billion
June: $176.365 billion
July: $174.664 billion
August: $173.818 billion
September: $171.152 billion
October: $171.091 billion
November: $168.425 billion
December: $169.430 billion

January 2010: $167.892 billion
February: $168.104 billion
March: $169.495 billion
April: $169.163 billion
May: $166.378 billion
June: $165.369 billion
July: $166.988 billion
August: $164.774 billion
September: $163.976 billion
October: $168.401 billion
November: $168.892 billion
December: $169.170 billion

January 2011: $170.42 billion
February: $171.800 billion
March: $174.028 billion
April: $175.198 billion
May: $173.974 billion
June: $176.527 billion
July: $177.574 billion
August: $177.654 billion
September: $176.856 billion
October: $178.214 billion
November: $176.705 billion
December: $180.526 billion

January 2012: $180.5 billion
February: $182.7 billion
March: $185.3 billion
April: $188.0 billion
May: $186.6 billion
June: $187.9 billion
July: $190.9 billion
August: $192.6 billion
September: $195.0 billion
October: $197.2 billion
November: $198.1 billion
December: $201.5 billion

January 2013: $200.8 billion
February: $204.8 billion
March: $209.1 billion
April: $210.0 billion
May: $209.2 billion
June: $212.5 billion
July: $216.6 billion
August: $215.3 billion
September: $217.8 billion
October: $218.7 billion
November: $219.5 billion
December: $220.6 billion

January 2014: $219.2 billion
February: $218.4 billion
March: $223.3 billion
April: $229.4 billion
May: $231.7 billion
June: $230.9 billion

Just think of what this could mean for bank earnings if the Prime rate was to go back to something more normal: like 5% or 6%. And, unlike in the USA (see prior post “Bloomberg: Regulators stand by while U.S. bank lenders get footloose” May 4-14), there’s no hint of weak covenant packages being used to win this business, either.


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Pension Pulse Poppycock

The world is full of bloggers; not the folks who think 140 characters of wit counts as blogging, mind you. I’m referring to the people who genuinely ply the trade, 500 or 1,200 words at a time, with real research or insightful commentary that’s grounded in their own area of professional or personal expertise.

We fellow travellers in this thankless task generally get along famously; who better to understand the fruitless exercise of writing into the ether than a fellow blogger? This rule of thumb was recently bruised broken when one of them, a guy named Leo Kolivakis, decided to take a crack at me in response to my most recent post regarding the CPP Investment Board (see prior post “CalSTRS exec gives a frank assessment of CPP Private Equity portfolio” July 15-14). His form of blogging seems to amount to reposting long articles from the media or industry press releases, and then dropping in his commentary here and there. Everyone has their own style.

He writes that he doesn’t “like” me. He’s not the first, and won’t likely be the last, unfortunately. Having not ever met the man, nor any of his friends or family I suspect, it seems quite judgmental if this silly blog is the source of his distain. He may well hate Billy Bishop Toronto City Airport, which I am blamed for from time-to-time, despite its 1939 founding; but, even then, I get along with lots of folks who take issue with the BBTCA (even the jet angle). Perhaps he’s a devotee of Kevin O’Leary (see representative prior post “Highlights of our Kevin O’Leary Blog Posts” Sept. 27-12). I suppose it doesn’t much matter; “haters are gonna hate” as they say.

My fellow blogger goes on to make clear that CPPIB is “a subscriber” to his blog. His Pension Pulse website states that institutions voluntarily pay $500, $1,000 or $5,000 a year for his posting efforts. There’s even a helpful “subscribe” Paypal button for those who don’t have a cheque writing machine. If only I’d known that this is how you can turn blogging into a profit centre: just put your hand out. If you tech entrepreneurial types had the same resources as the institutional investors that Leo’s writing for I might have been able to retire by now.

I appreciate Leo’s disclosure about his commercial relationship with Canada’s pension plan manager; transparency is key in life. Leo goes on to detail his apparently close relationship with CPPIB CEO Mark Wiseman. According to Leo, they emailed back and forth about the blog in question; let’s be honest — not everyone can get instant email responses from the CEO of a $200 billion fund. This Leo obviously has the attention of some members of the pension industry. Mr. Wiseman advised him that he hadn’t read the post, which is of great relief to me. If all of you would just join him and ignore the drivel herein, I could stop writing altogether (the reader I randomly met in a Costa Rican pool on March Break will attest to this speech: the sooner y’all stop wasting your time, the sooner I can hang up the blogging skates). Mr. Wiseman doesn’t have time to waste, which is one of the many reasons why he runs CPPIB and you don’t.

Perhaps Leo’s 21 months as a consultant at the Business Development Bank of Canada, where he was partly responsible for drafting its annual corporate plan during 2008-10, might explain his distain of this space (see prior representative post “C.D. Howe report recommends BDC mandate shake-up” Feb. 7-13).

Leo is quite confident that he can still be critical of CPPIB when required, despite his financial ties. The fact that he thinks my CPPIB analysis is flawed is, no doubt, completely unrelated to that fact that he’s on their payroll. The Globe and Mail didn’t find any such flaws, mind you. Since we all own the CPP’s assets, I suppose it is nice to know another fellow who is on our collective payroll. The good news is that his $5,000(?) annual fee isn’t so large as to have contributed materially to CPPIB’s outsized management expense ratio (see prior representative post “Why is CPPIB’s MER higher than its peers?” Jan. 9-13).

What’s really troubling about this fee-for-service arrangement is that Leo doesn’t come across as a very good analyst. His attempted knee-capping is rife with errors, flawed analysis and unsupported conclusions.

If he’s going to try to show his patron at CPPIB that he’s an effective hitman on their behalf, which may well be why he gave Mr. Wiseman the heads-up about his plans for a takedown, you’d think he’d be a bit more careful about doing some exacting research and nailing down his arguments prior to pulling the trigger. But, as we’ve come to learn, far too many “analysts” come off as CPP cheerleaders; even those who claim to be visionaries of the pension industry (see prior post “Professor Kesselman’s arguments for “Big CPP” don’t hold water” Nov. 26-13).

Here are a few of the quick highlights of Leo’s flawed analysis:

He starts off by saying that I have an “axe to grind”, which is a traditional slur used to undercut everything that someone writes on the basis that they have a hidden agenda. I’ve never thought any of ~2,500 blog posts I’ve written was driven by an agenda per se. A theme, perhaps, about honesty, transparency, fair dealing and so forth. But not an “agenda” in the political or commercial sense of the word. If I did have a agenda, surely I’d be falling all over myself paying CPPIB compliments left, right and centre in the hopes that they’d hire me to manage a few crumbs on their behalf.

Leo might have missed them, but many a positive word has been written here about CPPIB over the years. I was a fan of the 2009 Skype investment, I posted about the huge private equity NAV gains in 2010, CPPIB’s 10 year results exceeding the median found praise, as did the position it took on Income Trusts, for example.

It seems that Leo is confusing opinions on topics such as Management Expense Ratio, Value Add, exec comp, asset allocation choices and transparency/governance with an anti-CPPIB “agenda”. Perhaps that’s because no one on Bay Street says any of this publicly, but these topics are definitely yakked about over lunch or drinks by many a fund manager, trader and i-banker, albeit off the record, as MSM journos will attest.

Leo has no reason to know this, but the agency was practically founded by one of my Bay Street mentors, the late John MacNaughton, CM; attacking his creation for blogging fodder would be counterintuitive. As I like to remind everyone, these folks work for us, and we shouldn’t be browbeaten for asking good, respectful questions. Mr. MacNaughton never thought so, anyway; “that’s what makes a democracy”, he once said to me.

Leo on CPPIB investing in venture capital:

Most public pension funds are going to lose their shirts investing in VC. Anyways, all this to say that while McQueen wants CPPIB to invest directly in VC funds, I think he’s nuts and the evidence doesn’t support his case. Even if CPPIB did invest directly in VC and made money (a big IF), it would be peanuts in terms of the overall portfolio and wouldn’t make a big difference in terms of value add.

Perhaps Leo is new to this pension fund analysis gig, so we’ll cut him some slack. But he’s wrong nonetheless about “most public pension plans are going to lose their shirts investing in VC.” CPPIB, for example, has long invested in venture capital — does that make Mr. Wiseman and his predecessors “nuts”, Leo? CPPIB’s first direct Canadian VC commitment was back in 2000, seven years before this blog got started, and nine jobs/contracts ago for Leo (via LinkedIn). CPPIB committed directly to many Canadian VC names back then:

$50 million into Edgestone Venture Fund I; $25 million into Skypoint Telecom Fund I; US$13.5 million for Celtic House VP Fund II in 2002; $50 million for Celtic House’s follow-on Fund III; $50 million again into Edgestone Venture Fund II; $50 million for Ventures West 8 in 2003. There was also an indirect strategy, which was initially managed by Edgestone Partners until Northleaf took it over circa 2005.

Northleaf is currently managing a newish ~$150 million Canadian VC allocation for CPPIB, as part of a $400 million PE/VC Canadian Fund-of-Fund vehicle, although it has proven to be hard to track deployments (see prior post “Has anyone seen CPPIB’s venture bucks?” Nov. 2-12). What’s more, Leo, Mr. Wiseman actually thinks this is a good time to be investing new capital in the VC space. This is what he told Boyd Erman at the Globe, in February 2010:

“We believe that there’s an opportunity because we believe there are going to be excellent returns.”

As for most pension plans “losing their shirts” on venture capital, many of the largest plans in the world have made great money on the asset class, enjoying returns that are higher than private equity over the long term (see representative prior post “Buyout vs. Venture returns” Feb. 20-08). In Canada, OMERS has attracted plenty of attention with its $200 million direct VC strategy, and while some Canadian plans have backed out of the assets class (such as Ontario Teachers), several well-known American plans have been backing venture funds for decades.

The Washington State Investment Board’s VC portfolio has returned a multiple of capital of 1.5x since inception, for example. Exactly the same 1.5x multiple as both its “Large Buyout” and “Mid Buyout” investments, which include Apax, GTCR, KKR, TPG, Welsh Carson…. The same positive return, Leo. Do your homework!

Leo on direct versus indirect investing at CPPIB:

And unlike other large Canadian pension funds, CPPIB doesn’t invest directly in private equity or real estate (only in infrastructure).

Really? According to page 51 of the current annual report, Leo, CPP has just under $20 billion in “principal investments” within the Private Equity world. Those are directs (including co-invests), and don’t include our indirect PE exposure via our $38.5 billion of fund commitments.

Leo on CPPIB’s allocation to mega buyout private equity funds:

He’s right that CPPIB “doubled down” on buyout funds at the worst possible time but that’s because assets under management were ballooning at the time so they had to invest more in private equity.

At least we agree on something. What Leo has wrong is the claim that this happened because CPPIB’s “assets under management were ballooning at the time so they had to invest more in PE.”

To borrow from Don Drummond, another economist, “math is math.” Here’s some math for Leo to noodle.

According to CPPIB’s financial statements, total assets under management grew by $35 billion between 2004 and 2009 (about 50%). During that window, new CPPIB commitments to private equity funds amounted to $23.9 billion, while our actual “invested” PE portfolio grew by about $12 billion.

Remarkably, CPPIB committed more money to new PE funds between 2004 and 2009 than what Canadians were actually contributing to the CPP via source deductions and employer contributions. Here’s an analysis of “New PE Buyout Fund Commitments as a percentage of Net Contributions by Canadians and Canadian employers”:

2004: 13%
2005: 89%
2006: 189%
2007: 88%
2008: 107%
2009: 8%

You can see a table of the data here:

CPPIB PE flows

Surely Leo has reviewed the same CPPIB financial statements that we all have access to online. As such, I’m not sure how he could miss the fact that although our CPP assets grew quickly during that period, there were years where CPPIB was committing more to PE than they were actually taking in. Is that the “ballooning” that Leo was referring to?

One could observe that the investment cycle of PE is such that it takes years to deploy the capital once it has been committed. This is true, but as a percentage of assets under management, drawn PE dollars grew from 2.6% to 13.4% during this period just the same. We are talking invested dollars, not dollars that have been committed and not yet drawn by our 3rd party fund managers. Which means that our invested PE allocation, as a percentage of assets under management, grew more than five times during what Leo refers to as “the worst possible time”. We didn’t just “invest more” on a pro rata basis as the cash rolled in, as Leo claims. CPPIB increased its allocation five fold.

Thus the double-whammy to our financial statements, which may be one of the reasons why the CPPIB team generated negative value add for the four years ending 2013 (see prior post “CPP Investment Board has produced $1.8 billion of negative value-add over a four year period” May 20-13), as well as the 2014 fiscal year (after expenses).

Leo on the wisdom of CPPIB’s concentration in Private Equity:

Importantly, in markets where public equities roar, CPPIB will typically underperform its Reference Portfolio but in a bear market for stocks, it will typically outperform its Reference Portfolio. Why? Because private market investments are not marked-to-market, so the valuation lag will boost CPPIB’s return in markets where public equities decline.

There are two pretty big embarrassing problems here for Leo.

First, his suggestion that “private market investments are not marked-to-market” is just plain wrong. I’m neither an economist nor an accountant, but according to Accounting rule FAS 157, it’s a requirement (see prior posts “Accountants are failing investors with “fair value” accounting” Aug. 6-07, “D’Alessandro: fair market value accounting is ‘perverse’” Sept. 30-08, “New accounting rule adds to LBO pain” Mar. 2-09). And it’s been that way for years and years.

Second, I see no evidence to Leo’s assertion that CPPIB will “outperform its Reference Portfolio” during a bear market due to its large concentration in private equity assets. Perhaps there’s some academic support for the theory, but it didn’t play out in reality: during the “bear market” of 2008-09, which is one of the worst market windows since the Great Depression, CPPIB lost 18.6% (as of the FYE March 31, 2009). On a gross basis, the CPP fund met its Benchmark return, but after including the expense of the team managing the portfolio, CPPIB’s asset allocations and overall structure produced “negative value add” of about 15 bps, according to the 2009 financial statements. In a period where Canadian public equities lost 32.3%, for example, the structure didn’t perform in the manner that Leo says it will during a the next bear market. Let’s hope he’s right on the next one.

Leo can blame a “tough to beat” reference portfolio, but in 2010, for example, CPPIB’s performance was in the bottom decile according to RBC Dexia’s stats for pension plans (see prior post “CPPIB’s 2010 results put pension fund in bottom decile” May 21-10). And these are funds with allocations to private equity, real estate, bonds, hard assets and public equities; the same kinds of assets that CPPIB is buying.

I could go on, but unlike Leo, no one is paying me to blog. ;-)

Canadians are well-served by a thorough, healthy discussion about our collective retirement tools. The Fraser Institute provided its timely perspective a few months ago, for example. What undercuts the debate is specious analysis, rabid cheerleading and bromides.

(this post, like all blogs, is an Opinion Piece)

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Halogen’s valuation shadow could undercut Canada’s tech IPO momentum

The deals are there for Canadian technology companies and its broader ecosystem, that’s for sure.

Kinaxis (KXS:TSX), Critical Control (CCZ:TSX), DIRTT (DRT:TSX) and Espial (ESP:TSX) have all raised equity via public offerings over the past few weeks. And that’s just a representative list of Canadian-based tech firms which have been able to get something done in what I’ll call a less-than-perfect capital markets environment. The NASDAQ hasn’t been playing ball — slowing the U.S. tech IPO market to a trickle. U.S. SaaS multiples have contracted (although they don’t look horrible from an issuer’s standpoint), and several previous local IPO offerings haven’t yet produced sustainable gains for their IPO investors.

Names that come to mind include Difference Capital (DCF:TSX), Halogen Software (HGN:TSX), NexJ (NXJ:TSX), ViXS (VXS:TSX) and so forth. And while there’s nothing unusual about shares not going straight up post-IPO, one name in particular is drawing undue attention. And it may have a negative impact on the TSX for some time to come.

It seems that Halogen’s current valuation has raised concerns within certain corners of the American VC and Growth Equity community. The issue is simply Halogen’s crappy valuation as compared to the direct comps that trade on American stock exchanges. Halogen remains a growth story, and is largely playing out as promised on last year’s roadshow. Which makes it even harder for U.S. VCs with private Canadian tech investments to ignore that the stock is now trading around eight bucks, well below its $11.50 IPO price; this for a stock that hit $15.75 at one point last summer. Why list in Canada, they ask, if they undervalue our best investments?

Why does any of this matter? Simply because this Halogen situation is bouncing around Bay Street like a pinball, as investment banks firms pitch Desire2Learn, Hootsuite, Shopify and Vision Critical on the comforts and appeal of the TSX. There hasn’t been any punative pushback just yet, but some U.S. VCs have definitely soured for the moment on the concept. 10 years ago, Silicon Valley VCs were thought to see the entire Canadian public market as being just one big “Vancouver Stock Exchange”, and the TSX was rarely listed as a “qualified stock exchange” in U.S. VC-driven shareholder agreements; even when the investee company was Canadian-based.

Many private company CFOs will tell you that they’d like to list their companies on the TSX for patriotic reasons. They know, better than anyone, how important it is to have a robust local capital ecosystem. They don’t decide in a vacuum, however, since most VCs (particularly those with a Board seat) retain the right to approve an ultimate liquidity event. For the companies that aren’t big enough to attract Wall Street attention, the issue is moot. But its the large tech names that have the luxury of choice, and valuation is a (the?) key factor before deciding “to go out the door.”

The idea that the TSX is Siberia of stock exchanges for good tech companies is no more. But Halogen’s lacklustre trading over the past 90 days, through no fault of its own, might just set the local market back ten years if the quote doesn’t self-correct soon.

(disclosure: CCZ is a Wellington Financial Fund II portfolio company; Vision Critical is a Fund III portfolio company; I own ESP and HGN)

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