Caisse Bets Big on Insurance and Water?

Leo Kolivakis is a blogger, trader and independent senior pension and investment analyst. This post was originally published at Pension Pulse.

I wasn’t going to blog today but I realize that I’ve been slacking on my coverage of the Caisse. Two weeks ago, Devin Banerjee, Scott Deveau, and Frederic Tomesco of Bloomberg reported, Caisse Joins KKR in $4.3 Billion Deal for Onex’s USI Insurance:

KKR & Co. and Caisse de Depot et Placement du Quebec agreed to buy Onex Corp.’s USI Insurance Services for about $2 billion as the acquirers partner to make long-dated private equity investments.

KKR and CDPQ, Canada’s second-largest pension fund manager, will have equal ownership in the Valhalla, New York-based insurance broker, according to a statement Friday. The deal values USI at $4.3 billion including debt.

The acquirers also said they’ve established a partnership to make core private equity investments, or deals for stable companies they can hold for longer than the typical three- to five-year period in leveraged buyouts.

Private equity firms have long favored deals in insurance services, where capital expenditures and debt levels are typically low and cash flow is steady. KKR and CDPQ outbid others including buyout firms Carlyle Group LP and CVC Capital Partners for USI, according to people with knowledge of the process. Blackstone Group LP agreed last month to buy human-resources and benefits-administration platforms from broker Aon Plc for as much as $4.8 billion.

“Insurance is a defensive sector that generates a lot of cash and is relatively resilient to economic slowdowns and recessions,” Roland Lescure, CDPQ’s chief investment officer, said in a phone interview Friday. “The good thing about being a broker is that you are only an intermediary and you are not exposed to asset risk.”

Longer Ownership

KKR’s new partnership with CDPQ to make longer-hold investments reflects a wave of similar strategies by peers seeking to benefit from holdings that grow steadily and produce stable cash. Blackstone struck its first such deal in January, acquiring music-rights company SESAC Holdings, and Carlyle and CVC also have funds to make core private equity investments.

KKR co-founder Henry Kravis has lamented in the past that typical buyout fund structures don’t allow for longer ownership, calling Warren Buffett’s long-duration capabilities in Berkshire Hathaway Inc. “the perfect private equity model.”

“The goal is to look for longer-term, defensive deals — deals for which we are prepared to accept a little bit less leverage, a little bit smaller returns, because there is less risk and a greater resilience to economic slowdowns,” Lescure said of the strategy with New York-based KKR. “There’s no defined time horizon. Yes, it’s probable that in five, seven or 10 years we will decide to sell this business and move on. But neither KKR nor we have the obligation to sell.”

Onex, Canada’s largest buyout firm, agreed to buy USI from a fund run by Goldman Sachs Group Inc. in 2012, in a transaction valued at $2.3 billion. USI has since made more than 30 acquisitions to increase its network across the U.S., according to data compiled by Bloomberg. Onex and partners made a $610 million equity investment in the initial deal, which is now valued at 3.4 times that amount, the firm said in a separate statement Friday.

KKR has a long history in the business too, leading an investor group that bought a predecessor to Willis Group Holdings Ltd. and then took the broker public in 2001. Former Willis Chief Executive Officer Joe Plumeri was hired by KKR as an adviser in 2013 to help find new deals.

USI, founded in 1994, now has more than $1 billion in annual revenue and 4,400 employees in 140 offices across the U.S., according to its website. It offers a portfolio of diversified insurance and financial services to its customers.

Sweta Singh and Matt Scuffham of Reuters reported on a major deal, KKR, Canada’s Caisse to buy U.S. insurance broker USI:

Private equity firm KKR & Co LP (KKR) and Canadian pension fund Caisse de dépôt et placement du Québec announced plans on Friday to buy USI Insurance Services from Onex Corp (ONEX.TO) for $4.3 billion, including debt.

The deal is the latest in a string of mergers in the insurance market, which has not grown quickly enough to support smaller brokerages.

“It’s a sector we like,” Caisse Chief Investment Officer Roland Lescure said in an interview. “It’s quite defensive, it has high cash-flow generation, and it’s a growing sector where there is consolidation taking place.”

The Caisse, Canada’s second-largest public pension plan, is buying businesses to help it diversify from public equity and fixed income markets.

The pension fund, which has net assets of more than C$270 billion ($202 billion), wants to have 30 percent to 35 percent of its investments in areas such as private equity, infrastructure and real estate in the next four to five years, compared with 28 percent currently.

“At a time when there are lots of fears and questions on the potential protectionism and border adjustment tax,” Lescure said, “being exposed to small and medium companies is a safer way of exposing yourself to the U.S. economy.”

Valhalla, New York-based USI had net debt of about $1.82 billion as of Dec. 31 and generated 2016 earnings of $353 million before interest, taxes, depreciation and amortization.

USI provides insurance and employee benefit-related products to smaller U.S. companies. Its staff of 4,400 operates from 140 offices throughout the United States.

Canadian private equity firm Onex bought USI in December 2012 for $2.3 billion from Goldman Sachs Group Inc’s private equity arm, funding $702 million of that through equity and borrowing the rest, with debt placed on the company.

The biggest deal in the insurance brokerage sector last year was the merger of Willis Group Holdings and Towers Watson. It created Willis Towers Watson Plc, a company with a $17 billion market capitalization.

USI has been active in buying small regional rivals. It has been trying to beef up USI One Advantage, an interactive platform that helps it share information with sales consultants sitting in offices around the United States.

KKR and the Caisse said they expected the deal to close by the end of the second quarter.

Canadian Underwriter also reports, Caisse de dépôt et placement du Québec to buy stake in commercial brokerage USI from Onex:

Toronto-based Onex Corp. is selling its stake in one of the world’s largest commercial brokerages, USI Insurance Services LLC, to Caisse de dépôt et placement du Québec and other buyers.

Valhalla, N.Y.-based USI placed 11th worldwide in an earlier ranking by Finaccord Ltd., of commercial brokerages. USI has 140 offices in the United States, placing coverage for property, liability, auto, excess and environmental, among others.

Montreal-based Caisse de dépôt et placement du Québec manages funds, mainly for pension and insurance plans.

Onex said Friday that Onex and its affiliates agreed to sell USI to an affiliate of New York-based private equity firm Kohlberg Kravis Roberts and Co. LP and Caisse de dépôt et placement du Québec “for an enterprise value of $4.3 billion.” The sale, which is subject to regulatory approval and other conditions, is expected to close in Q2. In its Q4 2016 financial report, Onex said it owned 89% of USI.

KKR and CDPQ will be “partners with equal ownership” of USI, CDPQ stated.

New York City-based KKR said Friday that “KKR and CDPQ, along with USI employees,” agreed to jointly acquire USI.

“CDPQ and KKR are co-leading this investment and leveraging their respective expertise in the sector to support USI’s world-class management as it pursues its strategic plan for long-term growth,” stated Christian Puscasiu, co-head, direct investments, private equity at CDPQ, in a release. “USI operates in a resilient sector characterized by stable, long-term returns and serves small and medium-sized businesses, which are the cornerstone of the U.S. economy.”

Upon completion of the transaction, the Onex Group will have received proceeds of approximately (US) $2.1 billion, including a prior distribution of $181 million in 2015,” Onex said March 17 in a release.

In a 2014 report- Global Insurance Broking: A Strategic Review of the World’s Top 150 Commercial Non-Life Insurance Brokers – London-based Finaccord ranked the top 150 brokers by estimates of commercial non-life broking revenues in 2013. USI placed 11th. Finaccord’s estimates excluded revenues from personal lines, employee benefits, wholesale insurance and reinsurance. The top three were Aon, Marsh and Willis. Eight brokerages based in Canada made the top 150. Chicago-based Hub International Ltd. – whose Canadian operations include HKMB Hub and Totten Insurance Group – placed seventh.

Other firms in which Onex has an equity investment include claims services firm York Risk Services Group of Parsippany, N.J. and Toronto-based electronics equipment maker Celestica, which was spun off from IBM Corp. in 1996.

Onex was founded in 1983 by Gerry Schwartz, currently chairman, president and CEO.

Onex made a killing off this deal, buying USI from Goldman Sachs for $2.3 billion in December 2012 and selling it to the Caisse and KKR for $4.3 billion in a little over four years.

So, what is this major deal all about? It’s a large co-investment where KKR sourced the deal and presented a great opportunity to the Caisse to buy a growing US insurance broker which provides insurance and employee benefit-related products to smaller US companies.

Remember, fund investments and co-investments are an integral part of investing in private equity at Canada’s mighty PE investors. They invest in funds where they pay the big fees (typically 2 & 20) and then get to co-invest alongside them on bigger deals where they pay little or no fees (the bulk of their direct investments in private equity come from co-investments).

In order to do this properly, they need to 1) select the right private equity partners where they get solid alignment of interests and 2) hire smart people in private equity who can quickly analyze co-investments to limit turnaround time and act quickly when great opportunities present themselves.

Now, as far as this deal goes, the Caisse’s CIO Roland Lescure nailed it: “It’s a sector we like. It’s quite defensive, it has high cash-flow generation, and it’s a growing sector where there is consolidation taking place.”

What else? Interest rates are at historic lows and insurance companies have been struggling to generate revenues in this low rate environment. The ones that are growing, like USI, are growing through acquisition and when rates finally start creeping up, they will be well placed to generate even more revenues.

For the Caisse, this is a long-term investment which fits into its investment philosophy of investing in solid cash flow businesses across public and private markets.

What else has the Caisse been investing in lately? Earlier this month, Barbara Shecter of the National Post reported, Caisse de dépôt pumps US$700 million into GE water venture:

The Caisse de dépôt et placement du Québec is investing US$700 million for a 30 per cent stake in General Electric’s Water & Process Technologies business.

The Quebec pension giant is teaming up on the transaction with Paris-based sustainable resource management company SUEZ, which will contribute its existing industrial water business to GE Water and will own 70 per cent of the combined water treatment operation.

The transaction values the GE Water, which provides equipment, chemicals and services for the treatment of water and wastewater in 130 countries, at US$3.4 billion.

The Caisse is seeking to increase its exposure to the water sector and executives view Wednesday’s investment as a key part of that strategy to help create generate long-term returns.

“Operating in a core industry, GE Water has built a premier business with recurring revenues and a high-quality and diversified customer base,” Caisse chief executive Michael Sabia said in statement.

“This investment is therefore highly aligned with CDPQ’s long-term vision of increasing its emphasis on stable assets anchored in the real economy, alongside a world-class operator such as SUEZ.”

In a statement, the Caisse and SUEZ said growing water scarcity and the impact of global warming on the water cycle are expected to keep long-term demand strong for water treatment equipment, chemicals and services.

In addition, increasing global concerns related to industrial wastewater and its impact on the environment will make advanced treatment of water “an absolute necessity,” they said.

Water treatment plants are a big business and this deal will provide the Caisse solid returns over the long term.

You might be asking yourself what’s the link between the insurance business and water treatment business. For the Caisse, it all comes down to finding stable, growing businesses with recurring revenues to pay for their members’ long-dated liabilities.

And the Caisse’s CEO Michael Sabia has publicly warned of market complacency, so you know they are preparing for the next downturn and these private investments with stable revenues (yields) figure prominently into their overall defensive strategy.

The same goes for the rel estate investments where the Caisse and CPPIB recently teamed up to invest in Asian logistical warehouses, a great long-term deal for Canada’s largest pension funds.

Lastly, CBC News reported this week, Cost of Montreal’s light-rail train project rises by $500M:

The cost of a long-awaited Montreal light-rail commuter train line is going up by half a billion dollars.

CDPQ Infra, the subsidiary of the Caisse de dépôt et placement du Québec overseeing the project, presented an update Tuesday on the work done so far.

The project, which would link downtown Montreal with the South Shore and West Island, was initially pegged at $5.5 billion. Now it’s at $6 billion.

Quebec’s pension fund, the Caisse de dépôt et placement du Québec, is funding the project and has committed $3 billion to building the 67-kilometre light-rail transit system (LRT).

Michael Sabia, the head of the Caisse de Depot, said he isn’t worried about costs getting out of hand.

“It’s deliberate decision-making. It’s not costs just rising out of neglect or mismanagement — not at all,” Sabia said.

Those decisions include adding three new stations in Montreal and adding more cars to take the pressure off the Metro’s Orange line.

Sabia doesn’t believe the heftier price tag will affect ongoing funding negotiations with the federal government.

A good investment, environmental group says

Environmental group Équiterre considers the additional costs to be a good investment.

“There’s been a lack of investment in public transportation for years, so to see money being put into transportation for a project that has great impacts, we see it in a positive light,” said Colleen Thorpe, Équiterre’s director of education programs.

Deal with agricultural groups

The groups says it’s also pleased an agreement was struck to limit urban sprawl and protect farmland around the site of the South Shore station.

The consortium behind Montreal’s planned light rail project announced an agreement with local agricultural groups and municipalities to promote the use of agricultural land.

CDPQ Infra said the partnership will mean the creation of an agricultural land trust and, eventually, a park aimed at promoting the use of agricultural land.

“Through this agreement, we are laying the groundwork for a unique initiative to promote the use of the agricultural land located around the South Shore terminal station,” said Macky Tall, president of CDPQ Infra.

The consortium has been criticized by some environmental groups for failing to protect agricultural land.

The first trains are expected to run by the end of 2020.

Critics abound on Montreal’s light-rail transit system but as I already covered here, the public doesn’t have a full understanding of who these critics are and why they’re desperately trying to torpedo this project.

Moreover, I will state this one last time, greenfield projects of this scale and magnitude are always going to run into problems and cost overruns but I’d rather have the professionals at CDPQ Infra managing this project than some government bureaucrats awarding contracts to various construction companies (the Caisse assumes the risk of these cost overruns, not the Quebec government, so it’s in their best interest to try to minimize them as much as possible).

Again, the people working on this project are first-rate world class professionals who know what they’re doing and will deliver a great product on time and on budget. Sabia isn’t worried about costs getting out of hand and neither am I (keep in mind this project is Michael Sabia’s baby, he isn’t micromanaging it but he’s definitely present and takes an active part in the decision making).

That wraps up my overview of the Caisse’s Q1 activity. Below, Bloomberg’s Scott Deveau reports on the Caisse and KKR’s $4.3 billion deal to buy USI from Onex. I am glad private equity has discovered Warren Buffett and this this is a great deal for KKR and the Caisse.

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