Canadian duo following in the footsteps of the Search Fund Mafia

They are not coast-to-coast yet but search funds — a way for entrepreneurs to raise seed capital from a group of backers and then seek out a target — now stretch to Calgary in the west from Montreal in the east.

Recently formed Legado Capital has the distinction of being the first such entity in Western Canada. Based in Calgary, the search fund is the brainchild of Jeff Blacklock and Carlos Meza and is backed by a group of U.S and Canadian investors.

The investors have given the two founders — who met while each was doing their MBA at the University of Calgary — enough cash to allow them to search for an acquisition, to do the required due diligence, to make the purchase and fund it with additional capital from the original backers — and then to run the business.

That plan, whereby the new team will manage, and grow, the business explains the company’s name: Legado, a Spanish word, means legacy in English.

Blacklock and Meza — both of whom are engineers — became converts to the search fund model after they tried to buy a private company on their own. The two, after realizing that buying a business was more difficult and more expensive than they’d imagined, visited Stanford University — the institution that developed the model almost 50 years back.

The idea was to meet the so-called Search Fund Mafia, a group of investors who have backed numerous search funds. Armed with that knowledge, new contacts, one of which is the entrepreneur-in-residence at the Harvard Business School, and with capital from half a dozen investors, the pair then rounded up half a dozen Canadian investors.

Blacklock said the search fund model appeals “because we have a group of active investors. Not only do we have people backing us up with cash, they are also backing us up with their experience and knowledge.”

In addition, the model furnishes the two with resources to seek out potential targets. “This model provides funding to do that,” said Blacklock, adding it “allows younger entrepreneurs, who have a lot of energy and brains to execute on a business. It’s really tough to buy a business if you don’t have a structure behind you to get it done.”

Last fall and back in Canada the two tweaked the model: they recruited a group of students from the University of Calgary to help seek out potential targets by doing “proprietary outreach.”

The students, a mix of undergrads and MBAs, represent the third leg of the search process and are meant to complement the other two: leads that come from their own contacts and those that are provided by agents, the merry band of accountants and lawyers.

Legado has focused on targets in health care; testing, inspection and certification; and technological services. Potential targets are companies that have an enterprise value between $10 million and $30 million, that generate EBITDA in the $2 million — $6 million range, that have three years of stable cash flow and that are scalable, a feature that allows the business to grow.

Ideally the owner of the target business is either seeking to retire or to reduce their involvement in the business. “We are operating in the area that’s too big for most individuals but too small for either private equity investors or capital pool companies,” said Blacklock.

So far the search process has seen one letter of intent signed — but rejected. Currently there are discussions with three parties to determine whether there is a good fit.

Financial Post

bcritchley@postmedia.com

Stockmarket rally boosts Caisse de depot returns in 2016, but CEO sees ‘significant’ geopolitical risks

MONTREAL — La Caisse de depot said Friday it earned a 7.6 per cent return on investments last year, driven by the recovery in oil and commodity prices.

Net assets grew to $270.7 billion as of Dec. 31, said Quebec’s pension fund manager, Canada’s second largest by assets.

The annual result was better than the 5.8 per cent return for its benchmark portfolio, but less than the 9.1 per cent earned in 2015.

Over five years, the Caisse has generated 10.2 per cent in returns, adding $100 billion to the institutional investor’s assets.

“Our strategy, focused on rigorous asset selection, continues to deliver solid results,” CEO Michael Sabia said in a statement.

“On the economic front, the fundamental issue remains the same: slow global growth, exacerbated by low business investment. At the same time, there are also significant geopolitical risks. Given the relative complacency of markets, we need to adopt a prudent approach.”

Last year’s growth was led by equity investments, which account for nearly half of its portfolio. With a return of 10.4 per cent, those investments added $12.3 billion or two-thirds of the Caisse’s 2016 returns. That return was the lowest in five years, which peaked at 22.9 per cent growth in 2013.

A strong performance by the Canadian stock market and investments in companies with high U.S. exposure such as Alimentation Couche-Tard, Gildan and Magna generated a 22.7 per cent return.

Real estate and infrastructure investments also performed well, raking in a 10.6 per cent return.

Fixed income, which comprises a third of the Caisse’s portfolio, lagged with a 2.9 per cent return as low interest rates depressed returns for bonds, real estate debt and short-term investments.

The Canadian Press

OMERS investment returns surge 10% as net assets hit $85 billion

OMERS, the pension plan for Ontario’s municipal employees, posted an investment return of 10.3 per cent for 2016, net of all expenses.

The return beat both the benchmark of 7.9 per cent and the previous year’s return of 6.7 per cent.

Net assets grew to $85.2 billion, up $8.1 billion.

“Our strong investment returns in 2016 reflect the value of our well-diversified portfolio of high-quality assets, which we are continuously building,” said Michael Latimer, chief executive of OMERS. “All of our asset classes produced solid returns.”

The OMERS portfolio includes investments in public markets, private equity, infrastructure and real estate.

The pension’s funded status improved last year for the fourth year in a row, increasing to 93.4 per cent. It was boosted by both the strong investment returns and member and employee contributions.

One of Canada’s largest defined benefit pension plans, OMERS invests and administers pensions for more than 470,000 members from municipalities, school boards, emergency services and local agencies across Ontario.

bschecter@postmedia.com

RBC boosts dividend after profit surges 24% to $3 billion, beating expectations

TORONTO — Royal Bank of Canada boosted its first-quarter net income by 24 per cent to $3.03 billion.

That’s compared to the $2.45 billion of net income that RBC had during the first quarter of last year.

The Toronto-based bank said its net income was equal to $1.97 per diluted share for the quarter, up 39 cents from $1.58 per diluted share a year ago.

Revenue for the three months ended Jan. 31 was $9.55 billion, up from $9.36 billion during the same period last year.

After adjustments the lender had $1.87 per share of earnings, higher than the $1.77 per share that analysts had expected, according to Thomson Reuters.

After stripping out the sale of the U.S. operations of Moneris, RBC said it earned $2.82 billion, up 15 per cent from $2.45 billion a year ago.

The bank also boosted its dividend by four cents, or five per cent, to 87 cents per share, payable on May 24.

“RBC reported earnings of $3 billion for the first quarter reflecting strength across our businesses as we continued to invest in growth,” Dave McKay, RBC president and CEO, said in a statement.

“As the operating landscape evolves, we are focused on our strategy of building a digitally-enabled relationship bank to meet the changing expectations of our clients.”

One theory on how CIBC might up its offer for PrivateBancorp

Did the CIBC inadvertently indicate Thursday how much more it is prepared to offer to buy Chicago-based PrivateBancorp Inc., a company it agreed to purchase last fall?

At least one bank watcher thinks so. To reach that conclusion the observer drew a connection between the size of the newly unveiled 8 million share buyback program CIBC announced when it released its earnings Thursday, the workings of its stock-issuing dividend reinvestment program, and the need for the bank to increase the cash and stock offer that’s now required to acquire the publicly listed Private Bancorp.

Last June CIBC offered US$18.80 in cash and 0.3657 of a CIBC common share for each PrivateBancorp share, a combination that valued the offer at US$47.

But the rise in U.S. bank stocks following the election of Donald Trump meant that offer was below the target’s trading price. So last December PrivateBancorp called off a planned vote of its shareholders. And based on that formula, the offer is still a few dollars below PrivateBancorp’s trading price. To get the target CIBC will have to pay up.

The watcher, who requested anonymity, made one assumption: that CIBC, whose previous normal course issuer bid expired last September, will want to issue as many additional shares to acquire PrivateBancorp as it will want to buy back in the market. In this way, the bank will not suffer any extra dilution. Other corporations in similar M&A transactions have adopted similar anti-dilution strategies.

If the bank fully allocates the eight million shares available under the buy-back to the PrivateBancorp acquisition, then the purchase price would rise to about US$61 a share.

“That to me is the upper bound of how much they are willing to pay for the Private deal. I am left wondering whether there is any messaging in today’s (Thursday’s) disclosure through the normal course issuer bid,” noted the watcher.

Here’s the numbers: CIBC buys back 8 million shares – which costs about $1 billion or about US750 million at current prices. Given that the target has almost 80 million shares outstanding, the new offer is about US$9.375 a share higher than the previous offer.

In its most recent share buyback – it was allowed to purchase 8 million shares from September 2015 to September 2016 – CIBC underperformed, buying back 3.2 million shares.

CIBC wasn’t saying much Thursday about its plans regarding PrivateBancorp. “We will be disciplined. We will be patient. We have plenty of organic growth to deliver from our existing footprint as well,” said chief executive Victor Dodig.

Financial Post
bcritchley@postmedia.com

Royal Bank of Canada battles former executive after dropping Volcker strategy

Royal Bank of Canada is in a court battle with a former executive it dismissed after moving him to the Bahamas where it could continue a lucrative trading business hindered by U.S. regulations.

The dispute, according to court documents, centres on whether the former executive, Tebogo Phiri, has the right to valuable intellectual property such as data and trading strategies underpinning the business he ran for RBC. But it also reveals ongoing fallout from a controversial financial reform measure known as the Volcker rule banning proprietary trading, which banks have tried to fight in sundry ways.

Phiri first filed a lawsuit in New York State court in December against RBC’s U.S. investment banking division, saying his former employer had agreed in writing to let him take certain intellectual property if the business did not survive offshore. The information and trading strategies involved generate tens of millions of dollars in annual revenue, according to court filings.

Phiri’s group engaged in proprietary trading, in which a bank’s own capital is used to place speculative market bets. That type of trading was largely banned by the Volcker rule, which was part of a broad set of U.S. financial reforms after the 2008 crisis.

Lawyers for RBC and Phiri did not respond to requests for comment. A spokeswoman for RBC declined to comment. Phiri could not be reached for comment.

According to Phiri, RBC came up with a plan in 2015 to move him and other traders offshore because of the Volcker rule. An exception to the rule allows non-U.S. banks to engage in proprietary trading activity as long as the trading is conducted outside the United States.

But by mid-2016, the bank changed course and decided to shut down the Bahamas operation. RBC terminated Phiri’s employment in October, but did not grant him the intellectual property rights he was expecting, according to court papers.

Volcker hard to get around

Wall Street banks have fought hard against the Volcker rule on Capitol Hill and at regulatory agencies, and have recently been lobbying the new Congress to make changes that would soften its impact.

They have also taken advantage of exemptions related to hedging and merchant banking. But moving proprietary trading offshore has been a challenge for some foreign banks because of compliance issues.

“Many big global banks have ended up implementing Volcker procedures around the world anyway,” said John Williams, a partner at Milbank, Tweed, Hadley & McCloy. “Even if banks can take advantage of the exemption it’s hard to do so in a global market.”

The Botswana-born trader launched an arbitration proceeding before the Financial Industry Regulatory Authority (FINRA) seeking a decision that would allow him to use the intellectual property and award him more than US$2 million, according to court records.

He also filed the New York lawsuit, through which he obtained a court order in December preventing RBC from selling or transferring the intellectual property to third parties.

On Feb. 15, the FINRA panel granted Phiri’s request for an injunction. On Tuesday, RBC filed a new lawsuit seeking an order declaring FINRA’s ruling unenforceable.

The bank argues that FINRA’s decision is too vague to implement, while Phiri argues it grants him rights to the intellectual property at issue. RBC said doing so would cause “immediate and irreparable harm.”

© Thomson Reuters 2017

The Milestone move: release the good news early and the bad news late

In journalism it’s referred to as burying the lead, the much frowned upon practice of putting the most important part of the article in the eighth paragraph — by which time the reader has moved on.

In the world of corporate takeovers, there is a similar phenomenon which we could perhaps call the Milestone move — the practice of putting the positive news out early in the day and ensuring everybody is aware — and putting out the negative news late at night.

The Milestone move occurred this week as the REIT reacted to reports from two proxy advisory firms, both of which reached different conclusions on the merits of the US$16.15 a unit takeover offer from Starwood Capital. Milestone told the world about the positive recommendation from Glass Lewis before the markets opened — and the negative recommendation from ISS hours after the markets had closed.

Those two actions left one portfolio manager, slightly bewildered. “So Glass Lewis recommended shareholders vote in favor of the offer — and Milestone puts out a press release at 9 a.m., noting such.” The manager, who is not supporting the transaction, noted the contrast. “ISS recommends shareholders oppose the deal — and Milestone has an update at 10 p.m., when nobody is watching the news wires.”

So is Milestone managing the news, or was it just the way things worked out? Or was the late-in-the-evening release the result of having to work longer hours to compare what Glass Lewis got right and what ISS overlooked?

A Milestone representative said: “We can only comment when we see what the report says. The timing of the report does not change the positive message that we have been receiving from unit holders.” The meeting is scheduled for March 3.

In its report, Glass Lewis said “we see a reasonable basis for the board’s conclusion that the acquisition is in the best interests of the REIT and its unit holders at this time.” The report added that the price represents “a compelling value at which Milestone unit holders can cash out their investment.”

Glass Lewis also referred to “potentially negative headwinds on the horizon,” a view that didn’t make much sense to the portfolio manager. “Starwood has the same risk (as Milestone) and they are no dummies,” he said.

ISS had a different take and gave three reasons why a vote against the transaction was warranted. It noted that “speed and uncertainty were prioritized over price; that the offer “looks low based on multiple analyses;” and that there were numerous flags over “governance.”

It also noted that because negotiations were conducted with one party, the result might be “a sub-par offer compared to an auction or a market check process,” and further noted that Milestone’s “profile and industry fundamentals do not point to immediate threats to a standalone option.”

What has upset some unit holders and analysts is the timing of the going private transaction coming six months after the REIT paid $106.5 million, in cash and stock, to buy the management contract. That buy-out was meant to compensate for seven years of services and was based on a healthy ($300 million — $400 million) annual stream of acquisitions. Instead of seven years, the REIT received a mere six months of management.

When the Starwood deal was announced, Michael Markidis, the real estate analyst at Desjardins Capital Markets said: “We can’t help but wonder if entering into a friendly transaction was somewhat premature, especially since one could argue that several of the proposed benefits of the internalization had not fully percolated through to MST’s unit price.”

Financial Post
bcritchley@postmedia.com

Canadian securities watchdogs join forces to create regulatory ‘sandbox’ that will allow fintech startups to innovate

Canada’s provincial securities regulators have joined forces to create a regulatory “sandbox,” a system of tailored and flexible regulation for startup firms aiming to bring new business models to capital markets activities such as lending and financial advising.

The Canadian Securities Administrators, an umbrella organization for provincial market watchdogs, will assess the merits of each business model, on a case-by-case basis. Businesses that register or receive some relief from regulatory obligations, could be permitted to test their products and services throughout the Canadian market.

“The objective of this initiative is to facilitate the ability of those businesses to use innovative products, services and applications all across Canada, while ensuring appropriate investor protection,” said Louis Morisset, chair of the CSA and chief executive of Quebec’s Autorité des marchés financiers.

One of the unique features of the new system, which has been adopted in other jurisdictions such as the United Kingdom, is time-limited registration with regulators. This gives firms the ability to test out new technology or ideas without committing to the time and cost involved to obtain full regulatory oversight.

The new system will also allow for applications from incumbent firms for time-limited registration.

The types of firms expected to benefit from the regulatory sandbox approach fall broadly into the category of financial technology, or fintech. These include online lending and crowd funding platforms, angel investor networks, and securities trading and advising systems that take advantage of technological innovations, the CSA said.

Ventures using crypto-currency or distributed ledger technology will also be eligible to apply, as will startups with business models that make use of artificial intelligence for trades or recommendations.

Regulatory technology startups that offer risk management and compliance support services can also apply by contacting their local securities regulator.

Local regulators will refer eligible applicants to the CSA regulatory sandbox, provided their platform, product, or service offers “genuine technological innovation in the securities industry.”

The CSA says its staff may request live environment testing, a business plan, and demonstration of potential benefits for investors, as well as information on how investor risks are minimized.

The Ontario Securities Commission, Canada’s largest single capital markets watchdog, created its own fintech hub called OSC LaunchPad in October. It has since forged international cooperation agreements with regulators in Australia and the United Kingdom.