21 November 2019

TD CEO Bharat Masrani Knows When to Hold, or Fold, When the Stakes Are High

The Globe and Mail, Andrew Willis, 21 November 2019

Toronto-Dominion Bank chief executive Bharat Masrani, is one of those card sharks, caught in the late stages of a high-stakes game with Charles Schwab.

Do you ever watch poker tournaments on TV? Here’s what happens: The longer the game, the bigger the wagers get and the more likely players are to go bust when betting on a hand

Toronto-Dominion Bank chief executive Bharat Masrani is one of those card sharks, caught in the late stages of a high-stakes game in the U.S. discount brokerage industry. By all accounts, Mr. Masrani is about to do the sensible and boring thing, and walk away. It’s in keeping with an approach that colleagues say drives all the TD boss’s strategic decisions: Don’t do anything that could blow up the bank.

TD owns 43 per cent of TD Ameritrade Holding Corp. and is expected to support a widely reported but unconfirmed sale of the Omaha-based brokerage to industry leader Charles Schwab Corp. for US$26-billion in stock. Analysts project TD Bank will emerge from the transaction with a 10-per-cent to 15-per-cent stake in a merged company that dominates the do-it-yourself financial-services space.

Cutting a deal with Schwab would be a dramatic exit. Until now, Mr. Masrani backed increasingly large bets by the U.S. investment dealer. TD Ameritrade grew by making a series of acquisitions, each larger than the last. The most recent takeover, in 2016, saw TD Bank put up US$1.3-billion and TD Ameritrade throw in an additional US$2.7-billion to acquire rival Scottrade.

Another round of consolidation became all but inevitable in October, when Schwab decided to exploit its scale with a brilliant marketing move: It offered to let customers trade stocks for free. (Prior to that, Schwab charged US$4.95 per trade.) Schwab has approximately 12 million customers and more than US$3-trillion of assets under management.

Smaller rivals, including TD Ameritrade with about 11 million clients and US$1-trillion in assets, had no choice but to follow suit. The fee cuts will trim future profits, and TD Ameritrade lost a quarter of its market capitalization on the day Schwab changed the rules.

TD Ameritrade was widely expected to stage yet another takeover to keep pace with Schwab. “TD cannot stand still. This is a business of scale and they either have to get bigger or get out,” said Doug Steiner, former CEO of E*Trade Canada, which Bank of Nova Scotia acquired from E*Trade’s U.S. parent back in 2008 for $444-million.

TD Ameritrade’s logical target was New York-based E*Trade Financial Corp. But the table stakes have more than doubled since the Scottrade takeover. Acquiring E*Trade would cost at least US$10-billion. After putting that massive stack of chips into the game, Mr. Masrani would still own a large stake in a volatile brokerage business that is chasing the industry leader, and is not linked to TD’s core retail banking franchise.

TD’s other options included dropping US$12-billion to acquire 100 per cent of TD Ameritrade. Analyst Darko Mihelic ran the numbers in early October and said while the deal made strategic sense, there was no indication an offer was in the works. But Mr. Mihelic said the market expected a resolution on TD’s plans and "since this would be a large transaction with significant stock issuance, we believe many potential TD investors may stay on the sidelines for the foreseeable future.”

TD’s stock significantly under-performed Canadian peers in recent months, owing to uncertainty over the future of TD Ameritrade, according to analysts.

A deal with Schwab, if it happens, would make it easier for TD to expand in the United States, where it already has 1,250 branches. “Assuming a smaller stake in a bigger player situation, TD could have a more liquid asset that it could potentially sell to finance a future U.S. regional bank acquisition,” said Gabriel Dechaine, an analyst at National Bank Financial. In a report on Thursday, he said: “This scenario would be positive for TD’s long-term U.S. strategy.”

Over a 32-year-career at TD, including a four-year stint as chief risk officer, Mr. Masrani has seen the damage that can be done to a bank’s balance sheet when loans go bad, or a division stumbles. Long before former U.S. president Barack Obama made the phrase popular, TD’s boss lived by the motto “Don’t do stupid stuff.” Doing a deal with Schwab, rather than doubling down again on U.S. discount brokerages, is a winning bet.

15 November 2019

After A Rough Patch, Gerry Schwartz Bets On A New Approach at Onex

The Globe and Mail, Andrew Willis, 15 November 2019

Call it Onex 2.0.

Canada’s pioneering private-equity investor, Gerry Schwartz, is reinventing his firm on the fly. At a time when many of his billionaire peers are responding to increasing competition for deals – and their looming mortality – by closing down their funds to play with their grandkids, Onex Corp.’s 77-year-old founder and chief executive is in change mode at the $8-billion Toronto company.

Onex is shifting from selling primarily one product – leveraged buyouts – to a single group of customers – institutional investors – into a broader asset manager to try to win a following among wealthy, individual clients. Contemporaries such as Blackstone Group and Brookfield Asset Management are opening their doors to the same potential investors.

Mr. Schwartz is still staging bold takeovers, as witnessed by Onex’s unexpected $3.5-billion bid this spring for WestJet Airlines Ltd., two decades after the firm tried, and failed, to buy Air Canada. But the key to Onex’s future lies in a growth strategy that is partly based on fixing a struggling business, recently acquired money manager Gluskin Sheff + Associates Inc., and using its ties to affluent families to dramatically increase Onex’s size and profitability.

Mr. Schwartz, always introspective, and his senior colleagues also spent time this fall engaged in a productive session of corporate navel-gazing. The team stepped back and distilled the skills that helped Onex churn out an impressive 27-per-cent average annual return on investments over its 35-year history into a handful of lessons – call it the Gospel of Gerry.

The team also restructured the firm this fall, streamlining management and giving employees clear responsibility for specific investments in an effort to ensure accountability. These evolutionary steps are playing out at a time when Onex shares are underperforming the market. The company is struggling with a handful of problem children – a discount grocery chain and marine-survival equipment business – in its US$38-billion portfolio.

The reinvention of Onex started in June, when the firm closed its purchase of Gluskin Sheff for $445-million. The acquisition added plain-vanilla wealth management, in the form of funds that invest in stocks and bonds, to Onex’s more exotic investment offerings, which include funds that buy entire businesses and invest in loans and other credit products.

After quietly sewing the two businesses together over the past five months, Mr. Schwartz opened up about how everything is fitting together last week before an audience of 850 finance types at the Toronto CFA Society’s annual dinner. He started by highlighting the obvious, explaining Onex is always looking for new customers and it bought a platform that serves some of the wealthiest individuals in Canada. ”We think Gluskin Sheff represents a huge opportunity,” he said.

Then he dived into the strategy. Rather than competing based on low fees or last year’s performance numbers, he said, it’s all about trying to provide white-glove service to the rich. And that means more than investment products. ”Gluskin Sheff has the ability to be close to clients, to talk to them not just about their investment returns, but about their interests in philanthropy, then introduce them to charitable opportunities and build a vibrant, strong relationship.”

Gluskin Sheff opened its doors in 1984 and strove to build a brand that is to wealth management as Tiffany’s is to jewellery or Rolls-Royce is to your ride. Clients needed to commit a minimum of $3-million. For that price, they became members of an exclusive club with breathtakingly modern offices, plenty of hand-holding on financial decisions and head-turning events. The firm’s party to celebrate the Barnes exhibit of paintings at the Art Gallery of Ontario in 1994 is still a high-water mark in Toronto society.

That cachet took a beating after founders Ira Gluskin and Gerry Sheff stepped down as executives in 2009, and left the board in 2013. The two executives turned around and sued their former company for $185-million, claiming unpaid benefits. An arbitrator eventually awarded the duo $13.8-million in 2017. The dispute was a distraction for both Gluskin Sheff management and the company’s customers, most of whom had ties to the departed leaders.

Investment performance also became an issue for some clients. Prior to Onex’s arrival, Gluskin Sheff was bleeding assets. It went four consecutive years with existing clients pulling out more money than new customers put in. The outflow of funds was $235-million last year and $236-million the year before.

Onex is attempting to turn the tide with a renewed commitment to service and new flavours of investment products. Gluskin Sheff is out recruiting, with plans to build a team of seven experts focused solely on estate and tax planning. Financial results released last week show Gluskin Sheff clients committed US$199-million to Onex’s credit-based funds in the three months ended Sept. 30 – the first full quarter after the deal – and an additional US$52-million to Onex’s private-equity offerings.

In total, Gluskin Sheff takes care of US$6.4-billion, including US$60-million from Onex’s own employees. In a recent report, analyst Phil Hardie at Scotia Capital said: “The outflows Onex saw at Gluskin Sheff during the first half of the year appear to have slowed significantly.”

Onex, like other private-equity companies, earns the bulk of its profits when it sells businesses, but this income is lumpy. In contrast, Gluskin Sheff generates a steady stream of management fees. The firm charges clients a 1.5-per-cent commission on portfolios, plus performance fees that range from 10 to 25 per cent of investment gains. Those fees will translate into recurring profits for Onex.

That, in turn, is expected to mean a premium valuation for the company’s stock, according to analysts. Last year, Onex collected US$199-million in management fees. Onex projects that acquiring Gluskin Sheff will boost the total to US$328-million this year.

Onex is far from the only private-equity player striving for greater scale and more fees from taking care of other people’s money. The drive to diversify is playing out at U.S. private-equity pioneers KKR & Co. Inc. – a firm launched by Mr. Schwartz’s former colleagues at investment bank Bear Stearns – as well as New York-based Blackstone and Toronto-based Brookfield.

Onex is relatively a minnow in this school of fish. KKR is four times larger when it comes to assets under management, while Blackstone and Brookfield are more than 10 times its size. In an increasingly competitive industry, asset managers want to accumulate as much cash as possible to do the largest possible transactions, on the theory that there are fewer rivals for the biggest deals.

Onex’s founder is the first to concede the massive amount of capital now committed to private equity makes it increasingly difficult to find attractive targets. In his talk to the CFA Society, Mr. Schwartz said when he started his career in the 1970s, the total amount of capital committed to private equity, globally, was about US$300-million. Today, there is US$2.5-trillion looking for deals. Onex alone is sitting on more than US$2-billion of what is known in the industry as “dry powder,” or capital it is looking to put to use.

“It is a very, very difficult market,” said Mr. Schwartz. He said many private-equity fund managers are willing to risk overpaying to buy businesses because they are “desperate to get invested and move on to the next fund raise.”

Onex is willing to row against the tide. While the company is still scouting for takeovers and working to close the WestJet acquisition – the airline’s shareholders approved the deal in July but it still requires a thumbs-up from regulators – the priority is selling stakes in businesses, to take advantage of public markets that are hitting record highs. So far this year, Onex has raised more than US$900-million for its own account and millions more for clients by parting with holdings in seven businesses, including U.S. fast-food chain Jack’s and Swiss packaging company SIG Combibloc Group.

Onex plans to invest more money in fewer sectors. Historically, the company’s 119-member investment team cast a wide net for deals. After what analysts describe as an “operational review” that concluded ahead of its investor day in October, Onex conducted an internal restructuring that narrowed its focus to just four areas: industrial businesses, service companies, health care and financial services. Scotiabank’s Mr. Hardie said: “These cores notably exclude the retail segment, which we believe has been a source of some of its recent challenges.” (The boardroom discussion of the decision to avoid retailers would have been fascinating, as Heather Reisman, chief executive of bookstore chain Indigo Books & Music Inc., is both an Onex director and Mr. Schwartz’s wife.)

Onex is in the midst of a market slump, and a grocery-store investment is partly to blame. Its stock price is up 7.3 per cent year-to-date, while shares in peers such as KKR, Blackstone and Brookfield soared by between 45 and 85 per cent. Analysts say Onex shares now trade at a 15-per-cent discount to the underlying value of the company’s assets. While this has happened in the past, there have also been times when Onex stock commanded a premium to the value of its holdings.

Analysts trace the negative sentiment to investor concerns over two business that are turning in disappointing financial performance, U.S. discount grocery chain Save-A-Lot Ltd., which Onex acquired in 2016 in a US$1.4-billion transaction, and British marine-equipment supplier Survitec Group Ltd., bought in 2015 for £450-million. Analyst Geoffrey Kwan at RBC Dominion Securities said the problems, while significant, are in Onex’s past. “Underperforming investments have been written down to almost zero, so any further deterioration should have minimal impact on Onex,” Mr. Kwan said. “Historically, the best times to buy Onex were when the shares traded at a discount to net asset value.”

Onex’s recent makeover also saw the company rework its structure. Analysts say the company got rid of “pods” of employees who were assigned to sectors, deciding the structure limited the opportunities for its staff to get to know how each company really worked. Instead, executives assign employees direct responsibility for specific investments, in a drive to increase accountability.

Formal responsibility for running the firm’s different units went to three Onex senior managing directors: former banker Seth Mersky, ex-Berkshire Hathaway executive Bobby Le Blanc and Anthony Munk, son of entrepreneur Peter Munk. Each executive is in his 50s and has spent more than two decades at Onex. Those looking for signs of succession planning would start with this trio.

Finally, Mr. Schwartz and his colleagues came out of the management sessions with what could be described as Onex’s private equity playbook, or the Gospel of Gerry. Scott Chan, a Canaccord Genuity analyst, summed up their efforts by saying Onex created a formal process for investing that included “a dozen key criteria predictive of investment success, such as cost-savings, growth projections, valuation of tax assets, etc. This will help adopt a more agile and targeted investing approach.”

Onex deal makers all have a story on Mr. Schwartz’s dedication to the company and his passion for deals. Five decades into his career, he still makes calls on Sunday nights, sweats the details of pitches to potential targets and clients, and pushes to expand the company. The founder’s recent moves speak to his legacy. By acquiring Gluskin Sheff and attempting to instill a shared, methodical approach to investing, Mr. Schwartz is attempting to ensure Onex will have the scale and culture required to sail on, long after he leaves.

01 November 2019

Derek Neldner, New Head of RBC Capital Markets Has Work Cut Out for Him

The Globe and Mail, Rita Trichur, 1 November 2019

Derek Neldner took the reins as group head of RBC Dominion Securities Inc. on Friday, and he’s got his work cut out for him.

Make no mistake: RBC’s capital-markets arm still defines the big leagues on Bay Street and is a Top 10 global investment bank. But these days, its bankers have a little less reason to swagger. Corporate clients are more cautious about deal making and borrowing because of uncertainties stemming from a slower U.S. economy, Brexit and high-profile trade spats.

While those trends are weighing on investment banks around the globe, RBC’s bragging rights are also in shorter supply because of its own foul-ups. A spate of regulatory smackdowns, mostly south of the border, are creating new reputational risks for RBC’s capital-markets division which once prided itself on being the Boy Scout of investment banking.

Mr. Neldner, 46, has plenty of cred on the Street. But he still faces a formidable challenge. Not only must he propel new revenue growth without excessive risk taking, he must also keep his bankers and traders on a tighter leash. And if that wasn’t enough, his outspoken predecessor, Doug McGregor, will still be looking over his shoulder – at least for the time being.

Mr. McGregor, 63, spent more than a decade at the division’s helm, and during that time, earned a reputation for his blunt talk and imposing personality. On Friday, he became chairman of RBC’s capital-markets division and will remain in that job until he retires on Jan. 31, 2020.

It’s hard to imagine Mr. McGregor holding his tongue, especially given the division’s challenges. During its fiscal third quarter, net income and revenue from RBC’s capital-markets division fell – both year-over-year and quarter-over-quarter.

Results were hurt by lower investment-banking revenues, lower equities-trading revenue, a slowdown in mergers and acquisitions activity and bigger provisions for impaired loans.

While Mr. Neldner can’t control those macro trends, shareholders will expect him to improve certain financial metrics. For starters, the capital-markets arm’s return on equity of 11.1 per cent is sagging relative to the bank’s other divisions including personal and commercial banking (28 per cent), wealth management (17.2 per cent) and insurance (39.2 per cent).

There will also be more pressure to control costs, including in the way RBC pays its bankers and traders. The capital-markets division’s ratio of total compensation to revenue – which includes a variety of compensation costs including salary, benefits, stock-based compensation and retention bonuses – stood at 37.9 per cent during the third quarter.

Mr. Neldner, meanwhile, is also heir to other headaches, including the fallout from cultural and conduct problems.

Last year, RBC abruptly dismissed Blair Fleming, then-head of its U.S. capital markets business, after an internal investigation found he allegedly violated company policies pertaining to workplace relationships.

Mr. McGregor later encouraged employees to 'speak up' when they see improper behaviour, an obligation that Mr. Neldner now inherits as regulators sharpen their scrutiny of misconduct risks at banks.

The division’s compliance issues have come to the fore again in recent months. In August, RBC agreed to pay a $13.55-million financial penalty to the Ontario Securities Commission to settle charges that it failed to supervise foreign-exchange traders over a three-year period.

Regulators alleged that traders used electronic chatrooms to share confidential customer information with their peers at other companies between 2011 and 2013. What’s more, the OSC alleged that RBC didn’t completely correct its chatroom compliance problems until 2015. (Toronto-Dominion Bank separately agreed to pay the OSC $9.3-million).

And just last month, the Commodity Futures Trading Commission (CFTC) slapped RBC with a US$5-million fine for 'failing to meet its supervisory obligations, which resulted in hundreds of unlawful trades and other violations' from late 2011 through May 2017. This was despite the fact that RBC was punished for similar compliance violations in 2014, when it was ordered to pay a US$35-million penalty for engaging in illegal futures trading.

There’s no understating how harmful blunders such as these are to RBC’s brand, especially after the Michael Lewis book Flash Boys lionized the bank’s do-gooder culture.

The bank made public-relations hay from the publicity for years. Perhaps, its executives’ biggest mistake was believing their own PR.

Mr. Neldner, who has worked his way up the ranks at RBC since 1995, is now responsible for mopping up such messes. The bank cannot afford more hits to its reputation. His troops will have to fall into line.