TORONTO - The Ontario Teachers' Pension Plan intends to double the size of its merchant bank to C$8 billion (US$5 billion) in about three years as part of a move away from public equities.
The merchant bank of the C$68 billion pension fund last month completed two deals worth more than C$3.3 billion. On Sept. 18, the fund announced it would invest US$250 million in York Street Mezzanine Partners LP, a new U.S. fund that will focus on creating partnerships with private equity sponsors to provide mezzanine debt for middle-market U.S. companies. On Sept. 16, the bank announced its part in the largest leveraged buyout in Canadian history - a joint venture with Kohlberg Kravis Roberts & Co., New York, to pay C$3 billion for the telephone directories and other related businesses of Canadian telephone company BCE Inc. The fund will invest C$270 million for a 30% stake in the business, while KKR will invest C$540 million for a 60% stake. Bell Canada will continue to own 10%. The remaining C$2.1 billion will be financed with debt.
Doubling the assets
Jim Leech, senior vice president in charge of the merchant banking business, has been with the fund for about a year and has completed six transactions worth about C$800 million. He thinks it shouldn't be too difficult to double the merchant bank's assets in three to four years. "If it's a good market, we'll do it sooner," he said.
In the past year, the merchant bank has increased its professional staff to 21 from 12, and at any time it has "from 12 to 15 active files (deals) going," Mr. Leech said. "We average about 150 proposed transactions a year."
The York Street fund, based in Dedminster, N.J., can invest a portion of its capital in the equity of the companies it finances in addition to providing mezzanine debt. As York Street's primary capital sponsor, the teachers' merchant bank will have the opportunity to invest directly in the fund's larger transactions.
Mr. Leech said the merchant bank "had been looking for an appropriate vehicle to target mezzanine debt in the United States, which we felt was an underserved market." He said officials at the Ontario Teachers fund knew the two principals of the firm, managing partners Rob Golding and Chris Layden, when they worked at CIT Corp.
"We had looked with them at deals when they were at CIT," said Mr. Leech. "When they said they would be leaving, we approached them about being the prime capital sponsor for their new business," he added.
The businesses acquired in the BCE deal includes the Yellow Pages unit of Bell Canada, marketer and distributor of phone books to residents of Ontario and Quebec, as well as Internet directories YellowPages.ca and Canada411.com.
The deal fits the criteria Mr. Leech said the merchant bank is looking for in its deals.
"We're a traditional player," he said. "We don't look at real estate or mining. We look at old-economy companies with stable cash flow and a strong position in a niche market. We've traditionally stayed away from tech companies," said Mr. Leech. That's a bit of a turnabout for Mr. Leech, who for the 10 years before joining the pension fund was involved in the early development stages of two high-technology companies.
"When you're doing buyouts, you're looking for companies with substantial cash flows, and there aren't a lot of companies with substantial cash flows in the high-tech area," he added.
The merchant bank's deals over the past year include the C$220 million leveraged buyout of Osprey Media Holdings Inc., a Markham, Ont., newspaper chain, in which the merchant bank invested C$50 million in a partnership with private equity firm Scotia Capital. The merchant bank also invested US$35 million in the US$165 million leveraged buyout of Ames True Temper, Camphill, Pa., in partnership with Windpoint Partners, a U.S. private equity firm.
But technology isn't entirely off-limits. The merchant bank does have a venture capital unit with about C$400 million in assets, which Mr. Leech said will invest in high-tech companies. The unit is one of the largest pools of venture capital in Canada.
The venture capital unit recently put up US$3 million as part of a US$35 million financing deal for ISTA Pharmaceuticals, Irvine, Calif. The unit also invested US$3.5 million in the US$12 million financing of Potentia Power Systems Inc., Ottawa, Ont., a firm that makes semiconductors for power management modules.
The large commitment to merchant banking deals is partly due to fund officials' belief that public equity markets will underperform for the next several years. In June, the pension fund announced it was cutting its allocation to U.S. equities by one-third, to 10% from 15% of its portfolio (Pensions & Investments, June 24)
Patrick Walsh, a consultant with SEI Inc., Toronto, said it makes sense for the fund to do more private investing "because it can get improved returns and put money to work in areas where it can get involved with partners helping with the deals."