Direct effect

Three Canadian pensions are among the biggest direct private equity investors in the country. Teachers', OMERS and the Caisse are at turns partners, rivals and emulators of each other, and their respective programmes are the results of wildly divergent histories. David Snow reports from Toronto and Montreal

In a way, the development of Canadian institutional private equity has been the reverse of the US market – the most important investors north of the border spent years doing their own private equity deals before reluctantly deciding to pay third parties to do this work for them.

This culture of direct investing has remained strong through a recent period of significant growth and change at the private equity divisions of three major Canadian institutions.

Teachers' Merchant Bank of the Ontario Teachers Pension Plan is at the cusp of investing in Canadian megadeals on equal footing with giant American firms; OMERS Capital Partners, the private equity subsidiary of the Ontario Municipal Employees Retirement System, after an unusual sojourn as a private entity investor, has a fresh mandate from the pension to put capital to work; and Canada's dominant capital manager, Caisse de depot et placement du Quebec, has sharply consolidated its private equity operations and clarified its mission as a major player in the asset class.

Their styles are different but the message of all three institutions is the same: we have capital, expertise and access to local businesses, but if you're looking for plain-vanilla LP commitments, you've come to the wrong place.

Mark Wiseman, head of the fund and co-investment programme at Teachers' Merchant Bank, says the majority of hopeful GPs who visit his Toronto office are surprised to find themselves immediately screened from the pension's private equity programme. “They learn that we are unlike any institutional investor they have ever visited before,” says Wiseman. “What I run is not a funds programme, it's a funds and co-investment programme, and the real focus is on the second part of that.”

Adds Jim Leech, the head of Teachers' Merchant Bank: “We're quite open about it – we don't like doing funds. They cost us fees and carry.”

Unlike most other pension professionals, the 26 professionals on Leech's team are compensated based on the performance of the group's investments, similar in scale and style to the way investors at private funds are paid. This structure, in particular, has been the envy of Canada's other public investing institutions, and stands in sharp contrast to the turnover-plagued public institutions in the US.

When Leech, the former CEO of merchant bank Unicorp Canada, joined the pension in 2001, he was given a mandate to opportunistically grow its private equity programme to as much as C$10 billion (US$7.3 billion; €6 billion).

Since then, Teachers' has led or participated in a number of influential deals that further redefine traditional notions of how a pension should invest. For example, together with direct investment-oriented Dutch group NIB Capital (now AlpinVest Partners), Teachers' last year co-led the €1.5 billion (US$1.622 billion) spinout of private equity firm MidOcean Partners from Deutsche Bank in a highly complex transaction.

The firm has also been involved in two of the largest private equity deals in Canadian history – the 2000 buyout of Shoppers Drug Mart for C$2.55 billion and the 2002 acquisition of Bell Canada's directories business, now called Yellow Pages Group, in a deal worth C$3 billion. Both of those transactions were led by New York behemoth Kohlberg Kravis Roberts.

Yellow Pages in particular stands out as a soaring success. KKR contributed roughly two-thirds of the deal's C$900 million in equity. The company was subsequently taken public as an income trust, and KKR last month completed its exit with C$1.6 billion cash in hand (much to the chagrin of other Canadian private equity players – in 2002, Toronto buyout firm Onex joined the Caisse on a competing bid for the company).

Leech says his firm is very pleased with Yellow Pages (Teachers' continues to hold its stake in the company), but adds it and other successes have now allowed the pension to be more aggressive in leading large deals. “Now we would look to do a deal like Yellow Pages on a 50-50 basis” with major private equity firms like KKR, he says.

Teachers' is only interested in committing to funds that can provide the pension access to markets it can't otherwise enter on its own. And it only wants one fund per strategy – for example, Teachers' has partnered with BC Partners, which means largecap European deals are covered.

Finally, Teachers' insists on major, high-quality co-investment opportunities, to which the firm devotes the same analytical and due diligence resources as it does to its direct deals. Wiseman says his firm has had great co-investment success with smaller GP groups who can draw on Teachers' considerable resources for outsized deals. “We like to say that if you hunt gophers, continue to hunt gophers, but if you come across an elephant, give us a call,” Wiseman says.

As an example, Wiseman points to his group's recent co-acquisition of Alcoa's specialty chemicals division, now called Almatis. The deal was sourced by European middle market firm Rhone Capital Partners, a Teachers' fund relationship. The Almatis deal was too big for Rhone alone, so Teachers' dispatched a team to Europe and nine months later, in February, contributed 44 percent of the deal's US$120 million in equity.

Wiseman says his firm endeavors to put out a dollar in co-investments for every dollar it commits to funds. In its commitment to Rhone, this goal has been exceeded in the Almatis deal alone.

Perhaps you've never heard of OMERS Capital Partners. This wouldn't surprise David Rogers, a senior vice president at the Ontario pension and head of its private equity fund and co-investment programme. Rogers notes that the name is a new one. His team was recently combined with the private equity team of a firm called Borealis and both now reside under the OMERS umbrella.

The Borealis saga, in fact, has received much play in the Canadian press. But the pension's private equity professionals point out that the story has mostly to do with the real estate and infrastructure programmes.

Very long story short, in 2001, OMERS agreed to give private firm Borealis Capital (in which the pension had a 30 percent stake) the right to manage a portion of its massive real estate and all of its infrastructure holdings. Borealis also launched a C$378 million private equity fund for middlemarket Canadian deals, to which OMERS committed capital as an LP. At the same time, some members of the OMERS private equity team moved over to the private firm.

A source familiar with the arrangement says Borealis was a way for the pension's alternative investment teams to be paid near market levels. Two years later, when OMERS' new CEO Paul Haggis came on board, he brought Borealis in-house. In the process, certain Borealis shareholders received a 2.5-times windfall on their brief investment (noted with bemusement by the Canadian press), but now the combined former Borealis team and OMERS private equity professionals are moving toward a more competitive compensation structure, which will include long-term incentives and carry-like features.

“If you want to be the best-in-class, you need to hire best-in-class people,” says OMERS Capital CEO Ian Collier, a former Borealis shareholder. “It took a while for OMERS to realise that, but now they have and they're committed to growing the private equity programme.”

All this sets the stage for OMERS Capital Partners going forward, a topic Collier and Rogers are much more eager to discuss.

Like Teachers', OMERS' private equity history is rooted in direct deals. “We started doing directs in the mid- 1990s with a small team of four or five people,” says Rogers. “These were mostly based on personal relationships. We only got serious about fund investing in 2000 [when Rogers joined OMERS]. We now have 35 fund relationships and we are starting to leverage those for information and coinvestments.”

The 20-person OMERS Capital team has a new mandate to invest up to ten percent of the pension's C$35 billion in assets to private equity, half of which will go to funds and the other half split between co-investments and direct deals, the latter primarily in Canada. “We don't have an annual target and can put out C$500 million per year, or zero, depending on the opportunities we see,” says Rogers.

The firm's direct investment team is led by Don Morrison and Bruce Hetherington, the Borealis Private Equity Fund is led by Andre La Forge. Collier oversees all three divisions of OMERS Capital.

Late last year, OMERS Capital completed what it describes as an ideal transaction – the C$640 million privatisation of Canadian bathtub and shower maker Maax in partnership with Boston buyout firm JW Childs Associates. The deal, majority owned by JW Childs, with the remainder split between OMERS Capital and the Borealis fund, is Canada's largest public-to-private transaction ever.

Maax is based in Quebec, and Collier notes that the reshuffling at the Caisse allowed his firm step in (with a team of Francophone professionals) and take advantage of a deal in the traditional stomping ground of Canada's largest investing institution.

Few institutions dominate a region's investment scene quite like the Caisse does Quebec's. The capital manager has C$140 billion in assets under management as at December 31, 2003 and a long history of doing its own direct private equity deals, the majority of them in its home province. In recent years, the Caisse has added fund investments to the mix, but, like Teachers and OMERS, it expects significant co-investment opportunities.

Pierre Fortier, the head of the Caisse's private equity fund portfolio who joined the institution 21 years ago, remembers well the days before third-party funds. “For many years we did not have any investments in funds,” Fortier says. “It was mostly a culture of direct investors who were not afraid to work through the details. In 1995, we started to slowly add funds to diversify our portfolio both geographically and by sector.”

After a period of restructuring, Fortier says the private equity market should know this about the Caisse: “We're back at our normal pace. We have the team, we have the expertise and we have the cash.”

As of December 31, 2003, the Caisse's private equity programme is valued at roughly C$10.3 billion, with roughly half of that in direct investments. On the fund side, Fortier's group expects to commit roughly US$500 million per year, an allocation that has already been reached for 2004, but the team is always interested in good opportunities.

The overall private equity group, led by executive vice-president, private equity, Normand Provost, employs some 150 people.

As part of a broader restructuring, the Caisse's private equity group recently consolidated down to a single entity. Previously distinct subsidiaries dedicated to technology, communications, financial services and the US market, to name a few, are now under the same roof. The institution's in-house direct investment expertise and mandate remains broad. In February, for example, the Caisse joined Energy Investors Funds Group on a US$283 million equity investment in Astoria Energy, a New York City power plant.

Ernst & Young is currently helping the Caisse evaluate options for the management of a C$300 million portfolio of existing venture capital investments.

The Caisse de depot et placement du Quebec was created in 1965 by an Act of the National Assembly. Its mission was two-fold: create returns for its pension and insurance company clients, and help Quebec develop economically. How these dual mandates were to be executed has been an issue of great debate in recent years. In the wake of losses in 2001 and 2002, critics charged that the Caisse had stumbled where it sought a “Quebec-first” strategy.

But the Caisse's new CEO, Henri- Paul Rousseau, has stated unequivocally that economic development in Quebec means the superior investment performance of the Caisse, full stop. In any case, Fortier says his institution has always been focused purely on investment return, and that outside perceptions of social investing have been exaggerated.

Rousseau has also stated publicly that the Caisse should emulate the compensation structures of Teachers' and OMERS if it wants to enjoy the highest level of investment performance.

At a national assembly session next Fall, the Caisse's vision of the future will be submitted for parliamentary approval, and a long-dominant institutional investor will likely be primed for a new era of success.

PRIVATE PLAYERSThe largest private firms in the Canadian private equity industry

Name of firm Size of most recent direct fund (C$m)
Onex Corporation C$2,300
TD Capital C$635
Borealis Private Equity C$400
CIBC Wood Gundy Capital* C$400
Scotia Merchant Capital* C$400
ONCAP Investment C$400
CAI Capital C$375
EdgeStone Capital C$361
Clairvest Group C$220
Schroders Canada C$204
TriWest Capital C$120
Kilmer Capital C$104