Watchlist...Descartes Systems Group Inc...DSG on the TSX

Watchlist...Descartes Systems Group Inc...DSG on the TSX

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OVERVIEW

We use technology and networks to simplify complex business processes. We are primarily focused on logistics and supply chain management business processes. Our solutions are predominantly cloud-based and are focused on improving the productivity, performance and security of logistics-intensive businesses. Customers use our modular, software-as-a-service (“SaaS”) and data solutions to route, schedule, track and measure delivery resources; plan, allocate and execute shipments; rate, audit and pay transportation invoices; access and analyze global trade data; research and perform trade tariff and duty calculations; file customs and security documents for imports and exports; and complete numerous other logistics processes by participating in a large, collaborative multi-modal logistics community. Our pricing model provides our customers with flexibility in purchasing our solutions either on a subscription, transactional or perpetual license basis. Our primary focus is on serving transportation providers (air, ocean and truck modes), logistics service providers (including third-party logistics providers, freight forwarders and customs brokers) and distribution-intensive companies for which logistics is either a key or a defining part of their own product or service offering, or for which our solutions can provide an opportunity to reduce costs, improve service levels, or support growth by optimizing the use of assets and information.

The impact of the Pandemic on global trade both in the short-term and over the longer-term remains uncertain at this time. Since the start of the Pandemic in March 2020, we have observed some reduced shipment volumes across various modes of transportation and are aware of some customers who have reduced or temporarily suspended operations or are otherwise experiencing financial hardship. However, at the same time we have seen several other areas of our business where shipment and order volumes have remained stable or, in some cases, have seen increased volumes as a result of the Pandemic. We don’t know what the impact of these events will be on overall global trade volumes and the use of Descartes’ products and services by its customers and whether an impact will only be temporary or may continue for an extended period of time. It is also not clear at this time whether, as a result of the Pandemic and related events, companies and/or consumers will alter trading, manufacturing and/or buying patterns over the longer-term from the patterns we have observed in the global economy in the past.

The Market

Logistics is the management of the flow of resources between a point of origin and a point of destination – processes that move items (such as goods, people, information) from point A to point B. Supply chain management is broader than logistics and includes the sourcing, procurement, consumption by an enterprise. Logistics and supply chain management have been evolving over the past several years as companies are increasingly seeking automation and real-time control of their supply chain activities. We believe companies are looking for integrated solutions for managing inventory in transit, conveyance units, people, data and business documents.

We believe logistics-intensive organizations are seeking to reduce operating costs, differentiate themselves, improve margins, and better serve customers. Global trade and transportation processes are often manual and complex to manage. This is a consequence of the growing number of business partners participating in companies’ global supply chains and a lack of standardized business processes.

Additionally, global sourcing, logistics outsourcing, imposition of additional customs and regulatory requirements and the increased rate of change in day-to-day business requirements are adding to the overall complexities that companies face in planning and executing in their supply chains. Whether a shipment is delayed at the border, a customer changes an order or a breakdown occurs on the road, there are increasingly more issues that can significantly impact the execution of fulfillment schedules and associated costs.

The rise of e-commerce has heightened these challenges for many suppliers with end-customers increasingly demanding narrower order-to-fulfillment periods, lower prices and greater flexibility in scheduling and rescheduling deliveries. End customers also want real-time updates on delivery status, adding considerable burden to supply chain management as process efficiency is balanced with affordable service.

In this market, the movement and sharing of data between parties involved in the logistics process is equally important to the physical movement of goods. Manual, fragmented and distributed logistics solutions are often proving inadequate to address the needs of operators. Connecting manufacturers and suppliers to carriers on an individual, one-off basis is too costly, complex and risky for organizations dealing with many trading partners. Further, many of these solutions do not provide the flexibility required to efficiently accommodate varied processes for organizations to remain competitive. We believe this presents an opportunity for logistics technology providers to unite this highly fragmented community and help customers improve efficiencies in their operations.

As the market continues to change, we have been evolving to meet our customers’ needs. While the rate of adoption of newer logistics and supply chain management technologies is increasing, a large number of organizations still have manual business processes. We have been educating our prospects and customers on the value of connecting to trading partners through our Global Logistics Network (“GLN”) and automating, as well as standardizing, multi-party business processes. We believe that our target customers are increasingly looking for a single source, neutral, network-based solution provider who can help them manage the end-to-end shipment – from researching global trade information, to the booking of a shipment, to the tracking of that shipment as it moves, to the regulatory compliance filings to be made during the move and, finally, to the settlement and audit of the invoice.

Additionally, regulatory initiatives mandating electronic filing of shipment information with customs authorities require companies to automate aspects of their shipping processes to remain compliant and competitive. Our customs compliance technology helps shippers, transportation providers, freight forwarders and other logistics intermediaries to securely and electronically file shipment and tariff/duty information with customs authorities and self-audit their own efforts. Our technology also helps carriers and freight forwarders efficiently coordinate with customs brokers and agencies to expedite cross-border shipments. While many compliance initiatives started in the US, compliance has now become a global issue with significantly more international shipments crossing several borders on the way to their final destinations.

Increasingly, data and content have become central to supply chain planning and execution. Complex international supply chains are affected by logistics service provider performance, capacity, and productivity, as well as regulatory frameworks such as free trade agreements. We believe our Global Trade Data, Trade Regulations, Free-TradeAgreement, and duty rate and calculation solutions help customers improve their sourcing, landed cost, and transportation lane and provider selection processes.

Solutions

Descartes’ Logistics Technology Platform unites a growing global community of logistics-focused parties, allowing them to transact business while leveraging a broad array of applications designed to help logistics-intensive businesses thrive.

The Logistics Technology Platform fuses our GLN, an extensive logistics network covering multiple transportation modes, with a broad array of modular, interoperable web and wireless logistics management solutions. Designed to help accelerate time-to-value and increase productivity and performance for businesses of all sizes, the Logistics Technology Platform leverages the GLN’s multimodal logistics community to enable companies to quickly and cost-effectively connect and collaborate.

Descartes’ GLN, the underlying foundation of the Logistics Technology Platform, manages the flow of data and documents that track and control inventory, assets and people in motion. Designed expressly for logistics operations, it is native to the particularities of different transportation modes and country borders. As a state-of-the-art messaging network with wireless capabilities, the GLN helps manage business processes in real-time and in-motion. Its capabilities go beyond logistics, supporting common commercial transactions, regulatory compliance documents, and customer specific needs.

The GLN extends its reach using interconnect agreements with other general and logistic-sspecific networks, to offer companies access to a wide array of trading partners. With the flexibility to connect and collaborate in unique ways, companies can effectively route or transform data to and from partners and deploy additional Descartes solutions on the GLN. The GLN allows “low tech” partners to act and respond with “high tech” capabilities and connect to the transient partners that exist in many logistics operations. This inherent adaptability creates opportunities to develop logistics business processes that can help customers differentiate themselves from their competitors

Descartes’ Logistics Application Suite offers a wide array of modular, cloud-based, interoperable web and wireless logistics management applications. These solutions embody Descartes’ deep domain expertise, not merely “check box” functionality. These solutions deliver value for a broad range of logistics-intensive organizations, whether they purchase transportation, run their own fleet, operate globally or locally, or work across air, ocean or ground transportation. Descartes’ comprehensive suite of solutions includes:

• Routing, Mobile and Telematics;

• Transportation Management and ecommerce enablement;

• Customs & Regulatory Compliance;

• Trade Data;

• Global Logistics Network Services; and

• Broker & Forwarder Enterprise Systems.

The Descartes applications forming part of the Logistics Technology Platform are modular and interoperable to allow organizations the flexibility to deploy them quickly within an existing portfolio of solutions. Implementation is streamlined because these solutions use web-native or wireless user interfaces and are pre-integrated with the GLN. With interoperable and multi-party solutions, Descartes’ solutions are designed to deliver functionality that can enhance a logistics operation’s performance and productivity both within the organization and across a complex network of partners.

Descartes’ expanding global trade content offering unites systems and people with trade information to enable organizations to work smarter by making more informed supply chain and logistics decisions. Our content solutions can help customers: research and analyze global trade movements, regulations and trends; reduce the risk of transacting with denied parties; increase trade compliance rates; optimize sourcing, procurement, and business development strategies; and minimize duty spend.

Descartes’ GLN community members enjoy extended command of operations and accelerated time-to-value relative to many alternative logistics solutions. Given the inter-enterprise nature of logistics, quickly gaining access to partners is paramount. For this reason, Descartes has focused on growing a community that strategically attracts and retains relevant logistics parties. Upon joining the GLN community, many companies find that a number of their trading partners are already members with an existing connection to the GLN. This helps to minimize the time required to integrate Descartes’ logistics management applications and to begin realizing results. Descartes is committed to continuing to expand community membership. Companies that join the GLN community or extend their participation find a single place where their entire logistics network can exist regardless of the range of transportation modes, the number of trading partners or the variety of regulatory agencies.

Sales and Distribution

Our sales efforts are primarily directed towards two specific customer markets: (a) transportation companies and logistics service providers; and (b) manufacturers, retailers, distributors and mobile business service providers. Our sales staff is regionally based and trained to sell across our solutions to specific customer markets. In North America and Europe, we promote our products primarily through direct sales efforts aimed at existing and potential users of our products. In the Asia Pacific, Indian subcontinent, South America and African regions, we focus on making our channel partners successful. Channel partners for our other international operations include distributors, alliance partners and value-added resellers. During the ongoing period of the Pandemic we have been encouraged by the success of our sales organization to date in being able to continue to execute on sales efforts and prospecting through the use of online communication platforms and virtual meetings in place of face-to-face meetings and in person trade show events.

United by Design

Descartes’ ‘United By Design’ strategic alliance program is intended to ensure complementary hardware, software and network offerings are interoperable with Descartes’ solutions and work together seamlessly to solve multi-party business problems.

‘United By Design’ is intended to create a global ecosystem of logistics-intensive organizations working together to standardize and automate business processes and manage resources in motion. The program centers on Descartes’ Open Standard Collaborative Interfaces, which provide a wide variety of connectivity mechanisms to integrate a broad spectrum of applications and services.

Descartes has partnering relationships with multiple parties across the following three categories:

• Technology Partners – Complementary hardware, software, network, and embedded technology providers that extend the functional breadth of Descartes’ solution capabilities;

• Consulting Partners - Large system integrators and enterprise resource planning system vendors through to vertically specialized or niche consulting organizations that provide domain expertise and/or implementation services for Descartes’ solutions; and

• Channel Partners (Value-Added Resellers) – Organizations that market, sell, implement and support Descartes' solutions to extend access and expand market share into territories and markets where Descartes might not have a focused direct sales presence.

Marketing

Our marketing efforts are focused on growing demand for our solutions and establishing Descartes as a thought leader and innovator across the markets we serve. Marketing programs are delivered through integrated initiatives designed to reach our target customer and prospect groups. These programs include digital and online marketing, partner-focused campaigns, proactive media relations, and direct corporate marketing efforts. These efforts have also historically included trade shows and in-person user group events, but those activities have been suspended during the Pandemic. It is anticipated that some level of inperson events will return to our marketing programs following the Pandemic, but it is uncertain at this point to what extent.

Fiscal 2022 Highlights

On February 26, 2021, Descartes acquired all of the shares of VitaDex Solutions, LLC, doing business as QuestaWeb, a US-based provider of foreign trade zone and customs compliance solutions. The purchase price for the acquisition was approximately $35.9 million, net of cash acquired, which was funded from cash on hand.

On May 7, 2021, Descartes acquired all of the shares of Portrix Logistics Software GmbH (“Portrix”), a provider of multimodal rate management solutions for logistics services providers. The purchase price for the acquisition was approximately $25.1 million (EUR 20.7  million), net of cash acquired, which was funded from cash on hand.

As a result of the Pandemic, beginning in April 2020, many countries across the globe, including Canada, the United States and other countries in which we operate, ordered businesses to close or alter their day-to-day operations. In response, we quickly implemented measures that allowed our employees to safely work remotely from home locations, while allowing us to continue to operate our business and service our customers and engage with prospective new customers. In fiscal 2022, we’ve continued to see various countries locking down businesses as they’ve coped with further waves of the infections caused by the Pandemic. We’ve continued our work-from-home arrangements with our employees and continue to monitor the impacts of these shut-downs on our customers. 

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Management’s Discussion and Analysis...June 2, 2021

Source

https://www.sedar.com/GetFile.do?lang=EN&docClass=7&issuerNo=00003766&issuerType=03&projectNo=03234437&docId=4981100

Watchlist...Toromont Industries Ltd...TIH on the TSX

 Watchlist...Toromont Industries Ltd...TIH on the TSX

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CORPORATE PROFILE AND BUSINESS SEGMENTATION

As at December 31, 2020, Toromont employed over 6,000 people in more than 150 locations across Canada and the United States. Toromont is listed on the Toronto Stock Exchange under the symbol TIH.

Toromont has two reportable operating segments: the Equipment Group and CIMCO.

The Equipment Group includes Toromont CAT, one of the world’s larger Caterpillar dealerships, Battlefield – The CAT Rental Store, an industry-leading rental operation, SITECH, providing Trimble technology products and services, Toromont Material Handling, representing MCFA, Kalmar and other manufacturers’’ products, and AgWest, an agricultural equipment and solutions dealer representing AGCO, CLAAS and other manufacturers’ products. The Company is the exclusive Caterpillar dealer for a contiguous geographical territory in Canada that covers Manitoba, Ontario, Quebec, Newfoundland, New Brunswick, Nova Scotia, Prince Edward Island and most of Nunavut. Additionally, the Company is the MaK engine dealer for the Eastern Seaboard of the United States, from Maine to Virginia. Performance in the Equipment Group is driven by activity in several industries: road building and other infrastructure-related activities; mining; residential and commercial construction; power generation; aggregates; waste management; steel; forestry; and agriculture. Significant activities include the sale, rental and service of mobile equipment for Caterpillar and other manufacturers; sale, rental and service of engines used in a variety of applications including industrial, commercial, marine, on-highway trucks and power generation; and sale of complementary and related products, parts and service.

CIMCO is a market leader in the design, engineering, fabrication, installation and after-sale support of refrigeration systems in industrial and recreational markets. Results of CIMCO are influenced by conditions in the primary market segments served: beverage and food processing; cold storage; food distribution; mining; and recreational ice rinks. CIMCO offers systems designed to optimize energy usage through proprietary products such as ECO CHILL®. CIMCO has manufacturing facilities in Canada and the United States and sells its products and services globally

PRIMARY OBJECTIVE AND MAJOR STRATEGIES

The primary objective of the Company is to build shareholder value through sustainable and profitable growth, supported by a strong financial foundation. To guide its activities in pursuit of this objective, Toromont works toward specific, long-term financial goals (see section heading “Key Performance Measures” in this MD&A) and each of its operating groups consistently employs the following broad strategies:

Expand Markets

Toromont serves diverse markets that offer significant long-term potential for profitable expansion. Each operating group strives to achieve or maintain leading positions in markets served. Incremental revenues are derived from improved coverage, market share gains and geographic expansion. Expansion of the installed base of equipment provides the foundation for product support growth and leverages the fixed costs associated with the Company’s infrastructure. 

Strengthen Product Support

Toromont’s parts and service business is a significant contributor to overall profitability and serves to stabilize results through economic downturns. Product support activities also represent opportunities to develop closer relationships with customers and differentiate the Company’s product and service offering. The ability to consistently meet or exceed customers’ expectations for service efficiency and quality is critical, as after-market support is an integral part of the customer’s decision-making process when purchasing equipment.

Broaden Product Offerings

Toromont delivers specialized capital equipment to a diverse range of customers and industries. Collectively, hundreds of thousands of different parts are offered through the Company’s distribution channels. The Company expands its customer base through selectively extending product lines and capabilities. In support of this strategy, Toromont represents product lines that are considered leading and generally best-in-class from suppliers and business partners who continually expand and develop their offerings. Strong relationships with suppliers and business partners are critical in achieving growth objectives.

Invest in Resources

The combined knowledge and experience of Toromont’s people is a key competitive advantage. Growth is dependent on attracting, retaining and developing employees with values that are consistent with Toromont’s. A highly principled culture, share ownership and profitability-based incentive programs result in a close alignment of employee and shareholder interests. By investing in employee training and development, the capabilities and productivity of employees continually improve to better serve shareholders, customers and business partners. Toromont’s information technology represents another competitive differentiator in the marketplace. The Company’s selective investments in technology, inclusive of e-commerce initiatives, strengthen customer service capabilities, generate new opportunities for growth, drive efficiency and increase returns to shareholders. 

Maintain a Strong Financial Position

A strong, well-capitalized balance sheet creates stability and financial flexibility, and has contributed to the Company’s long-term track record of profitable growth. It is also fundamental to the Company’s future success. 

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Toromont, Annual Report, 2020

Watchlist...ATS Automation Tooling Systems Inc...ATA on the TSX

Watchlist...ATS Automation Tooling Systems Inc...ATA on the TSX

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COMPANY PROFILE

ATS is an industry-leading automation solutions provider to many of the world's most successful companies. ATS uses its extensive knowledge base and global capabilities to deliver custom automation, repeat automation, automation products and value-added solutions including pre-automation and after-sales services, to address the sophisticated manufacturing automation systems and service needs of multinational customers in markets such as life sciences, food & beverage, transportation, consumer products, and energy. Founded in 1978, ATS employs over 5,000 people at 28 manufacturing facilities and over 50 offices in North America, Europe, Southeast Asia and China.

STRATEGY

To drive the creation of long-term sustainable shareholder value, the Company employs a three-part value creation strategy: Build, Grow and Expand.

Build: To build on the Company’s foundation and drive performance improvements, management is focused on the advancement of the ATS Business Model (“ABM”), the pursuit and measurement of value drivers and key performance indicators, a rigorous strategic planning process, succession planning, talent management, employee engagement, and instilling autonomy with accountability into its businesses.

Grow: To drive organic growth, ATS develops and implements growth tools under the ABM, provides innovation and value to customers and works to grow recurring revenues.

Expand: To expand the Company’s reach, management is focused on the development of new markets and business platforms, the expansion of service offerings, investment in innovation and product development, and strategic and disciplined acquisitions that strengthen ATS. In executing this part of its strategy, the Company acquired CFT S.p.A., a global supplier of processing and packaging automation equipment for the food and beverage sector in the fourth quarter of fiscal 2021, and late in the first quarter of fiscal 2022, acquired BioDot, Inc. (“BioDot”), a leading manufacturer of automated fluid dispensing systems, as well as Control and Information Management Ltd. (“CIM”), an industrial automation system integrator based in Ireland.

The Company pursues these initiatives using a strategic capital allocation framework in order to drive the creation of long-term sustainable shareholder value.

ATS Business Model

The ABM is a business management system that ATS developed with the goal of enabling the Company to pursue its strategies, outpace the growth of its chosen markets, and drive year-over-year continuous improvement. The ABM emphasizes:

• People: developing, engaging and empowering ATS’ people to build the best team;

• Process: aligning ATS’ people to implement and continuously improve robust and disciplined business processes throughout the organization; and

• Performance: consistently measuring results in order to yield world-class performance for our customers and shareholders

The ABM is ATS’ playbook, serving as the framework utilized by the Company to achieve its business goals and objectives through disciplined, continuous improvement. The ABM is used by ATS divisions globally, supported with extensive training in the use of key problem-solving tools, and applied through various projects to drive continuous improvement.

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Management’s Discussion and Analysis...June 27, 2021

Source

https://www.sedar.com/CheckCode.do

Watchlist...Topicus Com Inc...TOI on the TSX

 Watchlist...Topicus Com Inc...TOI on the TSX

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Overview

We acquire, manage and build vertical market software (“VMS”) businesses, primarily located in Europe. Generally, these businesses provide mission critical software solutions that address the specific needs of our customers in particular vertical markets. Our focus on acquiring businesses with growth potential, managing them well and then building them, has allowed us to generate significant cash flows and revenue growth during the past several years.

Our revenue consists primarily of software license fees, maintenance and other recurring fees, professional service fees and hardware sales. Software license revenue is comprised of license fees charged for the use of our software products generally licensed under multiple-year or perpetual arrangements. Maintenance and other recurring revenue primarily consists of fees charged for customer support on our software products post-delivery and also includes, to a lesser extent, recurring fees derived from software as a service, subscriptions, combined software/support contracts, transaction-related revenues, and hosted products. Maintenance and other recurring fee arrangements generally include rights to certain product updates “when and if available”. Professional service revenue consists of fees charged for implementation and integration services, customized programming, product training and consulting. Hardware sales include the resale of third party hardware that forms part of our customer solutions, as well as sales of customized hardware assembled internally. Our customers typically purchase a combination of software, maintenance, professional services and hardware, although the type, mix and quantity of each vary by customer and by product.

Expenses consist primarily of staff costs, the cost of hardware, third party licenses, maintenance and professional services to fulfill our customer arrangements, travel and occupancy costs, depreciation and other general operating expenses.

Corporate Reorganization and Acquisition of Topicus.com B.V.

On January 4, 2021, Topicus completed a corporate reorganization (the “Combination”) pursuant to which it acquired a controlling interest in Topicus.com Coöperatief U.A. (“Topicus Coop”) (formerly named Constellation Software Netherlands Holding Coöperatief U.A. (“CSNH”)). Topicus Coop is an entity incorporated and domiciled in the Netherlands and, prior to the Combination, was controlled by Constellation Software Inc. (“CSI”), Topicus’ parent company and controlling shareholder. The Combination was completed between entities under common control and Topicus has recorded the Combination at carrying value of the net assets recorded in the financial statements of Topicus Coop. Topicus has amended its comparative financial information to reflect the Combination as if it had occurred before the start of the earliest period presented.

In conjunction with the Combination, Topicus issued 1 super voting share (the “Super Voting Share”), 39,412,385 preferred shares (the “Preferred Shares”) and 39,412,385 subordinate voting shares (the “Subordinate Voting Shares”) to CSI. CSI then distributed 39,412,367 Subordinate Voting Shares of Topicus to its shareholders pursuant to a dividend-in-kind previously declared. In addition, Topicus Coop issued 19,665,642 preference units (“Topicus Coop Preference Units”) and 19,665,642 ordinary units (“Topicus Coop Ordinary Units”) to Joday Investments II B.V. and certain individual investors affiliated therewith (being the previous minority owners of CSNH) (collectively known as the “Joday Group”). Topicus has reflected this capital reorganization as if it had occurred on the starting date of the earliest period presented for purposes of Topicus’ basic and diluted earnings per share calculation.

On January 5, 2021, the Company acquired 100% of the shares of Topicus.com B.V. from Ijssel B.V. (“Ijssel”). The Company paid cash of €133.6 million to Ijssel. Furthermore, the Company issued 5,842,882 Topicus Coop preference units to Ijssel for an initial subscription price of €83.8 million plus an additional subscription amount of €27.6 million which was paid by Ijssel to the Company in May 2021. The Company also issued 5,842,882 Topicus Coop Ordinary Units to Ijssel. The aggregate total consideration totalled €217.4 million.

The condensed consolidated interim financial statements of Topicus as at and for the three and six month periods ended June 30, 2021 and June 30, 2020 comprise Topicus, Topicus Coop and its subsidiaries (together referred to as the "Company") and the Company's interest in associates. Topicus’ principal subsidiary is Topicus Coop and Topicus has a common equity interest of 61.41% in Topicus Coop with 38.59% being owned by the noncontrolling interests. 

Non-controlling interests

The Company’s non-controlling interest at June 30, 2021 is associated with Topicus Coop, an entity domiciled in the Netherlands. Topicus Coop’s equity consists of Topicus Coop Ordinary Units. There are currently 64,920,909 Topicus Coop Ordinary Units outstanding, which are held by Topicus Coop’s unitholders as follows:

• Topicus: 39,870,435 Topicus Coop Ordinary Units, representing 61.41% equity ownership.

• Joday Group: 19,665,642 Topicus Coop Ordinary Units, representing 30.29% equity ownership.

• Ijssel: 5,384,832 Topicus Coop Ordinary Units, representing 8.29% equity ownership.

All of the Topicus Coop Ordinary Units held by the Joday Group and Ijssel (collectively the “Topicus Coop Exchangeable Units”) are exchangeable, directly or indirectly, for Subordinate Voting Shares. The Topicus Coop Exchangeable Units comprise non-controlling interests in Topicus Coop. 

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MANAGEMENT’S DISCUSSION AND ANALYSIS (“MD&A”)...August 4, 2021

Source

https://www.sedar.com/DisplayCompanyDocuments.do?lang=EN&issuerNo=00050502

Watchlist.....TELUS International...TIXT on the TSX

Watchlist.....TELUS International...TIXT on the TSX

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Overview of the Business

TELUS International is a leading digital customer experience innovator that designs, builds and delivers next-generation solutions for global and disruptive brands. Our services support the full lifecycle of our clients’ digital transformation journeys and enable them to more quickly embrace next-generation digital technologies to deliver better business outcomes. We work with our clients to shape their digital vision and strategies, design scalable processes and identify opportunities for innovation and growth. We bring to bear expertise in advanced technologies and processes, as well as a deep understanding of the challenges faced by all of our clients, including some of the largest global brands, when engaging with their customers. Over the last 16 years, we have built comprehensive, end-to-end capabilities with a mix of industry and digital technology expertise to support our clients in their customer experience and digital enablement transformations.

TELUS International was born out of an intense focus on customer service excellence, continuous improvement and a values-driven culture under the ownership of TELUS Corporation, a leading communications and information technology company in Canada. Since our founding, we have made a number of significant organic investments and acquisitions, with the goal of better serving our growing portfolio of global clients. We have expanded our agile delivery model to access highly qualified talent in multiple geographies, including Asia-Pacific, Central America, Europe and North America, and developed a broader set of complex, digital-centric capabilities.

We believe our ability to help clients realize better business outcomes begins with the talented team members we dedicate to supporting our clients because customer experience delivered by empathetic, highly skilled and engaged teams is key to providing a high-quality brand experience. We have a unique and differentiated culture that places people and a shared set of values at the forefront of everything we do. Over the past decade, we have made a series of investments in our people predicated upon the core philosophy that our “caring culture” drives sustainable team member engagement, retention and customer satisfaction.

We have expanded our focus across multiple industry verticals, targeting clients who believe exceptional customer experience is critical to their success. Higher growth technology companies, in particular, have embraced our service offerings and quickly become our largest and most important industry vertical. Today, we are a leading digital customer experience (CX) innovator that designs, builds and delivers next-generation solutions for global and disruptive brands. We believe we have a category-defining value proposition with a unique approach to combining both digital transformation and CX capabilities.

We have built comprehensive, end-to-end capabilities with a mix of industry and digital technology expertise to support our clients in their customer experience and digital enablement journeys. Our services support the full scope of our clients’ digital transformations and enable clients to more quickly embrace next-generation digital technologies to deliver better business outcomes. We provide strategy and innovation, next-generation technology and IT services, and CX process and delivery solutions to fuel our clients’ growth. Our highly skilled and empathetic team members together with our deep expertise in customer experience processes, next-generation technologies and expertise within our industry verticals are core to our success. We combine these with our ability to discover, analyze and innovate with new digital technologies in our digital centres of excellence to continuously evolve and expand our solutions and services.

We have built an agile delivery model with global scale to support next-generation, digitally-led customer experiences. Substantially all of our delivery locations are connected through a carrier-grade infrastructure backed by cloud technologies, enabling globally distributed and virtualized teams. The interconnectedness of our teams and ability to seamlessly shift interactions between physical and digital channels enables us to tailor our delivery strategy to clients’ evolving needs. We have over 56,000 team members in 50 delivery locations and global operations across over 25 countries. Our delivery locations are strategically selected based on a number of factors, including access to diverse, skilled talent, proximity to clients and ability to deliver our services over multiple time zones and in multiple languages. We have established a presence in key global markets, which supply us with qualified, cutting-edge technology talent and have been recognized as an employer of choice in many of these markets. In addition, TELUS International AI Data Solutions (which includes the data annotation business we acquired from Lionbridge Technologies Inc. at the end of 2020) utilizes the services of crowdsourced contractors that are geographically dispersed across the globe.

Today, our clients include companies across high-growth verticals, including Tech and Games, Communications and Media, eCommerce and FinTech, Healthcare and Travel and Hospitality. Our relationship with TELUS Corporation, one of our largest clients and controlling shareholder, has been instrumental to our success. TELUS Corporation provides significant revenue visibility, stability and growth, as well as strategic partnership with respect to co-innovation within our Communications and Media industry vertical. Our master services agreement with TELUS Corporation (TELUS MSA) provides for a term of ten years beginning in January 2021 and a minimum annual spend of $200 million, subject to adjustment in accordance with its terms. For more information, see “Item 7B—Related Party Transactions—Our Relationship with TELUS—Master Services Agreement” in our Annual Report.

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Recent Developments

On July 2, 2021, we completed the acquisition of Playment, a Bangalore, India-based leader in computer vision tools and services specialized in 2D and 3D image, video and LiDAR (light detection and ranging). The acquisition builds upon our existing deep domain expertise and experience in data annotation, uniquely positioning us to support technology and large enterprise clients developing AI-powered solutions across a variety of vertical markets. This acquisition was not material to our condensed interim consolidated financial statements.

On February 3, 2021, we completed our initial public offering (IPO) where we issued 20,997,375 subordinate voting shares at $25.00 per share. Net proceeds were used to repay a portion of outstanding borrowings under our credit agreement. As a result of the IPO, our subordinate voting shares are listed for trading on the New York Stock Exchange and the Toronto Stock Exchange.

On December 31, 2020, we acquired Lionbridge AI, the data annotation business of Lionbridge Technologies, Inc., pursuant to the terms of a stock purchase agreement, dated November 6, 2020 for cash consideration of $940 million, subject to post-closing adjustments. In the second quarter of 2021, we rebranded the business to TELUS International AI Data Solutions (TIAI). TIAI is one of only two globally-scaled, managed AI training data and data annotation services and platform providers in the world.

In April 2020, we acquired Managed IT Services business (MITS), a leading provider of managed IT services in Canada, offering a mix of cloud technologies, IT sourcing and managed hosting, from TELUS Corporation, our controlling shareholder, in exchange for share consideration with a value of $49 million.

On January 31, 2020, we completed the acquisition of Competence Call Center (CCC), a leading provider of higher value-added business services with a focus on customer relationship management and content moderation, for cash consideration of $873 million.

We have consolidated TIAI, MITS and CCC in our financial results since the closing of each of the acquisitions.

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Factors Affecting Our Performance and Related Trends

A comprehensive list of risk factors that may impact our business performance are described under section “Item 3D-Risk Factors” in our Annual Report. We believe that the key factors affecting our performance and financial performance include:

Our Ability to Expand and Retain Existing Client Relationships and Attract New Clients

We have a diverse base of clients, including leaders and disruptors across the industry verticals we serve. Through our commitment to customer experience and innovation, we have been able to sustain long-term partnerships with many clients, often expanding our relationship through multiple service offerings that we provide through a number of delivery locations.

To grow our revenue, we seek to continue to increase the number and scope of service offerings we provide to our existing clients. In addition, our continued revenue growth will depend on our ability to win new clients. We seek to partner with prospective clients that value premium digital IT and customer experience solutions and services.

Our ability to maintain and expand relationships with our clients, as well as to attract new clients, will depend on a number of factors, including our ability to maintain: a “customers-first” culture across our organization; our level of innovation, expertise and retention of team member talent; a consistently high level of service experience, as evidenced by, among others measures, the satisfaction ratings that our clients receive from their customers based on the services we provide; the technological advantages we offer; and our positive reputation, as a result of our corporate social responsibility initiatives and otherwise.

Our Ability to Attract and Retain Talent

As at June 30, 2021, we have over 56,000 team members located across over 25 countries in four geographic regions, servicing clients in almost 50 languages. In addition, our recently-acquired TIAI business utilizes the services of crowdsourced contractors that are geographically dispersed across the globe.

Ensuring that our team members feel valued and engaged is integral to our performance, as our team members enable us to maintain the organizational culture that is one of the key factors which differentiates us from our competitors, and creates a better experience for our clients’ customers, enabling us to retain and enhance our existing client relationships and build new ones. As a result, we make significant investments to attract, select, retain and develop top talent across our product and service offerings. We have devoted, and will continue to devote, substantial resources to creating engaging, inspiring, world-class physical workplaces; recruiting; cultivating talent selection proficiencies and proprietary methods of performance measurement; growing employee engagement including rewards and development; supporting our corporate sustainability initiatives; and ability to attract and retain team member talent will depend on a number of factors, including our ability to: compete for talent with competitive service providers in the geographies we operate; provide innovative benefits to our team members; retain and integrate talent from our acquisitions; and meet or exceed evolving expectations related to corporate sustainability.

Seasonality

Our financial results may vary from period to period during any year. The seasonality in our business, and consequently, our financial performance, generally mirrors that of our clients. Our revenues are typically higher in the third and fourth quarters than in other quarters.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...July 30, 2021

Source

https://www.sedar.com/DisplayCompanyDocuments.do?lang=EN&issuerNo=00051147

Cash as a Strategic Asset

 Cash as a Strategic Asset

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In my 13 years of investing I've almost always been fully invested or thereabouts. I have ridden down all the crashes and corrections during that time and was ultimately rewarded for hanging on when the market recovered and took me back up regaining all of my losses and eventually posting more gains as well. It was in keeping with my strategy of not having to make a lot of decisions about investing in the stock market. 

The frustrating thing though was watching the market put all the good quality companies (that were always too expensive to buy)  on sale and having no cash to take advantage of it. Still over the long haul this approach of always being fully invested has worked out for me.

Now I know a lot of fund managers always hold some cash as a 'strategic asset' to be employed during market down turns. And as an avid reader of Brookfield's letter to the shareholders I have read about their strategy of 'capital recycling'...

So as the market has continued to rise (albeit less robustly) over the summer I have for the first time started to trim some of my holdings. Mostly holdings that don't pay a high dividend nor grow it too much);.

So i trimmed my positions in Analog Devices (ADI on the NYSE), Open text (OTEX on the TSX) and Altus Group Ltd (AIF on the TSX)...When AIF announced great quarterly earnings last week and went up 14 percent in a day, I sold the rest of my holdings.

So now I'm 10 percent in cash and waiting for some market weakness. 

In keeping with this theme I have put together a watchlist of some Canadian companies that I may be interested in purchasing in case the market brings them down to a more acceptable price level...

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Watchlist as of August 22, 2021

AIF...ALTUS GROUP LIMITED...$65.45

TOI...TOPICUS.COM INC...$114.20

TIXT...TELUS INTERNATIONAL (CDA) INC...$39.65

DSG...DESCARTES SYSTEMS GROUP INC...$94.04

TIH...TOROMONT INDS LTD...$108.85

ATA...ATS AUTOMATION TOOLING SYSTEMS INC...$44.05

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I have owned TIH, DSG, ATA in the past and sold them too soon (part of the learning process I suppose) and of course I've just sold my remaining position in AIF. Actually I sold both TIH and DSG when they going for fifty-something...ouch!

All of these companies have good smart management teams along with well thought out business models.

In the upcoming days I will do a brief blogpost highlighting some of these companies...Maybe my intuition will be sparked and I will have a chance to add some of these names to my portfolio.

Bank on It

Bank on It

Valuing Financial Service Companies

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Through The Decades, banks and insurance companies have been touted as good investments for risk averse investors who value dividends. Invest in Citigroup (CITI) and American Insurance Group (AIG), they were told, and your investment will be safe. Not only did these firms pay large and stable dividends, but they were regulated. The banking crisis of 2008 revealed that even regulated firms can be guilty of reckless risk taking. While some of these firms may be good investments, buyers have to do their homework, assessing the sustainability of dividends and the underlying risk.

Financial service businesses fall into four groups depending on how they make their money.

A bank makes money on the spread between the interest it pays to those from whom it raises funds and the interest it charges those who borrow from it, and from other services it offers to depositors and its lenders. 

Insurance companies make their income in two ways. One is through the premiums they receive from those who buy insurance protection from them and the other is income from the investment portfolios that they maintain to service the claims. 

An investment bank provides advice and supporting products for other firms to raise capital from financial markets or to consummate transactions (acquisitions, divestitures). 

Investment firms provide investment advice or manage portfolios for clients. Their income comes from fees for investment advice and sales fees for investment portfolios. With the consolidation in the financial services sector, an increasing number of firms operate in more than one of these businesses.

Financial service firms are regulated all over the world, and these regulations take three forms. 

First, banks and insurance companies are required to meet regulatory capital ratios, computed based upon the book value of equity, to ensure that they do not expand beyond their means and put their claimholders or depositors at risk. 

Second, financial service firms are often constrained in terms of where they can invest their funds. For instance, until a decade ago, the Glass-Steagall Act in the United States restricted commercial banks from investment banking activities as well as from taking active equity positions in nonfinancial service firms. 

Third, the entry of new firms into the business is often controlled by the regulatory authorities, as are mergers between existing firms.

The accounting rules used to measure earnings and record book value are also different for financial service firms than those for the rest of the market. The assets of financial service firms tend to be financial instruments such as bonds and securitized obligations. Since the market price is observable for many of these investments, accounting rules have tilted towards using market value for these assets—marked to market, so to speak.

Valuation Issues

There are two primary challenges in valuing banks, investment banks, or insurance companies. The first is that drawing a distinction between debt and equity is difficult for financial service firms. When measuring capital for nonfinancial service firms, we tend to include both debt and equity. With a financial service firm, debt has a different connotation. Debt to a bank is raw material, something to be molded into other products that can then be sold at a higher price and yield a profit. In fact, the definition of what comprises debt also is murkier with a financial service firm than it is with a nonfinancial service firm, since deposits made by customers into their checking accounts at a bank technically meet the criteria for debt. Consequently, capital at financial service firms has to be narrowly defined as including only equity capital, a definition reinforced by the regulatory authorities, who evaluate the equity capital ratios of banks and insurance firms.

Defining cash flow for a bank is also difficult, even if it is defined as cash flows to equity. Measuring net capital expenditures and working capital can be problematic. Unlike manufacturing firms that invest in plant, equipment, and other fixed assets, financial service firms invest primarily in intangible assets such as brand name and human capital. Consequently, their investments for future growth often are treated as operating expenses in accounting statements. If we define working capital as the difference between current assets and current liabilities, a large proportion of a bank’s balance sheet would fall into one or the other of these categories. Changes in this number can be both large and volatile and may have no relationship to reinvestment for future growth.

The same issues rear their head in relative valuation. Multiples based upon enterprise value are very difficult, if not impossible, to compute for financial service firms. Controlling for differences in growth and risk is also more difficult, largely because accounting statements are opaque.

Valuation Solutions

If you cannot clearly delineate how much a financial service firm owes and what its cash flows are, how can you ever get an estimate of value? We deploy the same techniques in both intrinsic and relative valuation to overcome these problems: We value equity (rather than the firm) and use dividends, the only observable cash flow.

Intrinsic Valuation

If you accept the propositions that capital at a bank should be narrowly defined to include only equity, and that cash flows to equity are difficult (if not impossible) to compute because net capital expenditures and working capital cannot be defined, you are left with only one option: the dividend discount model. While we spend the bulk of this section talking about using dividends, we also present two other alternatives. One is to adapt the free cash flow to equity measure to define reinvestment as the increased regulatory capital required to sustain growth. The other is to keep the focus on what financial service firms generate as a return on equity, relative to the cost of equity, and to value these excess returns.

Dividend Discount Models

In the basic dividend discount model, the value of a stock is the present value of the expected dividends on that stock. For a stable growth dividend-paying firm, the value of a stock can be written as follows:

(value of equity = expected dividends next year / cost of equity - expected growth rate)

In the more general case, where dividends are growing at a rate that is not expected to be sustainable or constant forever during a period, we can still value the stock in two pieces: the present value (PV) of dividends during the high growth phase, and the present value of the price at the end of the period, assuming perpetual growth. The dividend discount model is intuitive and has deep roots in equity valuation, and there are three sets of inputs in the dividend discount model that determine the value of equity. 

The first is the cost of equity that we use to discount cash flows, with the possibility that the cost may vary across time, at least for some firms. 

The second is the proportion of earnings that we assume will be paid out in dividends; this is the dividend payout ratio, and higher payout ratios will translate into more dividends for any given level of earnings. 

The third is the expected growth rate in dividends over time, which will be a function of the earnings growth rate and the accompanying payout ratio. In addition to estimating each set of inputs well, we also need to ensure that the inputs are consistent with each other.

There are three estimation notes that we need to keep in mind, when making estimates of the cost of equity for a financial service firm.

Use sector betas: The large numbers of publicly traded firms in this domain should make estimating sector betas much easier.

Adjust for regulatory and business risk: To reflect regulatory differences, define the sector narrowly; thus, look at the average beta across banks with similar business models. Financial service firms that expand into riskier businesses—securitization, trading, and investment banking—should have different (and higher) betas for these segments, and the beta for the company should reflect this higher risk.

Consider the relationship between risk and growth: Expect high growth banks to have higher betas (and costs of equity) than mature banks. In valuing such banks, start with higher costs of equity, but as you reduce growth, also reduce betas and costs of equity.

Consider a valuation of Wells Fargo (WFC), one of the largest commercial banks in the United States, in October 2008. To estimate the cost of equity for the bank, we used a beta of 1.20, reflecting the average beta across large money-center commercial banks at the time, a risk-free rate of 3.6 percent, and an equity risk premium of 5 percent.

Cost of equity = 3.6% + 1.2(5%) = 9.6%

There is one final point that bears emphasizing here. The average beta across banks reflects the regulatory constraints that they operated under during that period. Since this valuation was done 4 weeks into the worst banking crisis of the last 50 years, there is a real chance that regulatory changes in the future can change the riskiness (and the betas) for banks.

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Value Driver #1: Equity Risk

While financial service firms may all be regulated, they are not equally risky. How does your firm’s risk profile compare to that of the average firm in the sector?

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There is an inherent tradeoff between dividends and growth. When a company pays a larger segment of its earnings as dividends, it is reinvesting less and should thus grow more slowly. With financial service firms, this link is reinforced by the fact that the activities of these firms are subject to regulatory capital constraints; banks and insurance companies have to maintain equity (in book value terms) at specified percentages of their activities. When a company is paying out more in dividends, it is retaining less in earnings; the book value of equity increases by the retained earnings. In recent years, in keeping with a trend that is visible in other sectors as well, financial service firms have increased stock buybacks as a way of returning cash to stockholders. In this context, focusing purely on dividends paid can provide a misleading picture of the cash returned to stockholders. An obvious solution is to add the stock buybacks each year to the dividends paid and to compute the composite payout ratio. If we do so, however, we should look at the number over several years, since stock buybacks vary widely across time—a buyback of billions in one year may be followed by three years of relatively meager buybacks, for instance.

To ensure that assumptions about dividends, earnings, and growth are internally consistent, we have to bring in a measure of how well the retained equity is reinvested; the return on equity is the variable that ties together payout ratios and expected growth.

Expected growth in earnings = Return on equity * (1 − Dividend payout ratio)

The linkage between return on equity, growth, and dividends is therefore critical in determining value in a financial service firm. At the risk of hyperbole, the key number in valuing a bank is not dividends, earnings, or expected growth, but what we believe it will earn as return on equity in the long term. That number, in conjunction with payout ratios, will help in determining growth. Returning to the October 2008 valuation of Wells Fargo, the bank had reported an average return on equity of 17.56 percent in the trailing 12 months. We assumed that regulatory capital ratios would rise, as a result of the crisis, by about 30 percent, thus reducing the return on equity to 13.51 percent:

Wells Fargo paid 54.63 percent of its earnings as dividends in the trailing 12 months. Assuming that payout ratio remains unchanged, the estimated growth rate in earnings for Wells Fargo, for the next five years, is 6.13 percent:

Expected growth rate = 13.51%(1 − .5463) = 6.13%

Table 9.1 reports Wells Fargo forecasted earnings and dividends per share for the next five years.

Table 9.1 Expected Earnings and Dividends for Wells Fargo in October 2009

This linkage between growth, payout, and ROE is also useful when we get to stable growth, since the payout ratio that we use in stable growth, to estimate the terminal value, should be:

payout ratio in stable growth = expected growth rate / stable period roe

The risk of the firm should also adjust to reflect the stable growth assumption. In particular, if betas are used to estimate the cost of equity, they should converge towards one in stable growth. With Wells Fargo, we assume that the expected growth rate in perpetuity after year 5 is 3 percent, that the beta drops to one in stable growth (resulting in a cost of equity of 8.60 percent), and that the return on equity in stable growth is also 8.60 percent.

payout ratio in stable growth = 1 -  (3.00% / 8.60%) = 65.12%

terminal price = eps in year 6 x stable payout ratio / cost of equity - expected growth rate

terminal price = 2.91(1.03)(.6512) / (.086 - .03) = $34.83

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Value Driver #2: Quality of Growth

Growth can add, destroy or do nothing for value. What return on equity do you see your firm generating, as it pursues growth?

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Discounting the expected dividends for the next 5 years (from Table 9.1), and the terminal price back at the current cost of equity of 9.60 percent, yields a value per share of $27.74, slightly less than the prevailing price at the time.

Cash Flow to Equity Models

Earlier in the chapter, we looked at the difficulty in estimating cash flows when net capital expenditures and noncash working capital cannot be easily identified. It is possible, however, to estimate cash flows to equity for financial service firms, if you define reinvestment differently. With financial service firms, the reinvestment generally is in regulatory capital; this is the capital as defined by the regulatory authorities, which, in turn, determines the limits on future growth. To estimate the reinvestment in regulatory capital, we need to define two parameters. The first is the target book equity capital ratio that the bank aspires to reach; this will be heavily influenced by regulatory requirements but will also reflect choices made by the bank’s management. Conservative banks may choose to maintain higher capital ratios than required by regulatory authorities, whereas aggressive banks may push towards the regulatory constraints.

To illustrate, assume that you are valuing a bank that has $100 million in loans outstanding and a book value of equity of $6 million. Assume that this bank expects to make $5 million in net income next year and would like to grow its loan base by 10 percent over the year, while also increasing its regulatory capital ratio to 7 percent We can compute the cash flow to equity thus:

Net income = $5.00 million

Reinvestment = $1.70 million (7% of $110 million − $6 million)

Cash flow to equity = $3.30 million

This cash flow to equity can be considered a potential dividend and replace dividends in the dividend discount model. Generalizing from this example, banks that have regulatory capital shortfalls should be worth less than banks that have built up safety buffers, since the former will need to reinvest more to get capital ratios back to target levels.

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Value Driver #3: Regulatory Buffers

Shortfalls (safety buffers) in regulatory capital can affect future dividends. How does yourfirm’s capital ratio measure up against regulatory (and it’s own) requirements?

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Excess Return Models

The third approach to valuing financial service firms is to use an excess return model, where excess returns are defined as the difference between ROE and the cost of equity. In such a model, the value of equity in a firm can be written as the sum of the book value of equity the value added by expected excess returns to equity investors from these and future investments.

Value of equity = Equity capital invested currently + Present value of expected excess returns to equity investors

The most interesting aspect of this model is its focus on excess returns. A firm that invests its equity and earns just the fair-market rate of return on these investments should see the market value of its equity converge on the equity capital currently invested in it. A firm that earns a below-market return on its equity investments will see its equity market value dip below the equity capital currently invested. The two key inputs into the excess return model are the return on equity and the cost of equity.

Excess equity return = (Return on equity − Cost of equity) (Equity capital invested)

Framing the value of financial service firms in terms of excess returns also provides insight into the risk/return tradeoff that they face. Faced with low returns on equity in traditional banking, many banks have expanded into trading, investment banking, real estate, and private equity. The benefits of moving into new businesses that offer higher returns on equity can be partly or completely offset by the higher risk in these businesses. To analyze a bank you need to look at both sides of the ledger: the return on equity the bank generates on its activities and the risk it is exposed to as a consequence. The excess returns approach also provides a framework for measuring the effects of regulatory changes on value. Increases in regulatory capital requirements will reduce return on equity and by extension, excess returns and values at banks.

We can frame the Wells Fargo valuation in excess returns terms. The book value of equity at Wells Fargo in October 2008 was $47.63 billion. The present value of excess returns, assuming that it can maintain its current return on equity of 13.51 percent and cost of equity of 9.60 percent forever, is approximately $58.22 billion. Adding this to the book value yields a value for equity of $105.85 billion and a value per share of $28.38 per share, very close to the estimate we obtained in the dividend discount model.

Relative Valuation

In keeping with our emphasis on equity valuation for financial service firms, the multiples that we will work with to analyze financial service firms are equity multiples—PE ratios and price-to-book ratios.

The PE ratio for a bank or insurance company is measured the same as it is for any other firm, by dividing the current price by earnings per share. As with other firms, the PE ratio should be higher for financial service firms with higher expected growth rates in earnings, higher payout ratios, and lower costs of equity. An issue that is specific to financial service firms is the use of provisions for expected expenses. For instance, banks routinely set aside provisions for bad loans. These provisions reduce the reported income and affect the reported price/earnings ratio. Consequently, banks that are more conservative about categorizing bad loans will report lower earnings, whereas banks that are less conservative will report higher earnings. Another consideration in the use of earnings multiples is the diversification of financial service firms into multiple businesses. The multiple that an investor is willing to pay for a dollar in earnings from commercial lending should be very different from the multiple that the same investor is willing to pay for a dollar in earnings from trading. When a firm is in many businesses with different risk, growth, and return characteristics, it is very difficult to find truly comparable firms and to compare the multiples of earnings paid across firms.

The price-to-book-value ratio for a financial service firm is the ratio of the price per share to the book value of equity per share. Other things remaining equal, higher growth rates in earnings, higher payout ratios, lower costs of equity, and higher returns on equity should all result in higher price to book ratios, with return on equity being the dominant variable. If anything, the strength of the relationship between price to book ratios and returns on equity should be stronger for financial service firms than for other firms, because the book value of equity is much more likely to track the market value of existing assets. While emphasizing the relationship between price to book ratios and returns on equity, don’t ignore the other fundamentals. For instance, banks vary in terms of risk, and we would expect for any given return on equity that riskier banks should have lower price to book value ratios. Similarly, banks with much greater potential for growth should have much higher price-to-book ratios, for any given level of the other fundamentals.

Assume that you were looking at Tompkins Financial (TMP), a small bank trading at 2.75 times book value in early 2009. That was well above the median value of 1.13 for price-to-book ratios for small banks at the time. However, Tompkins Financial also has a much higher return on equity (27.98%) and lower risk (standard deviation = 27.89%) than the median small bank, both of which should allow the firm to trade at a higher multiple. Using a technique adopted in prior chapters, the price-to-book ratio is regressed against ROE, growth, and standard deviation.

PBV = 1.527 + 8.63 (ROE) − 2.63 (Standard deviation) R2 = 31%

Plugging in the ROE (27.98%) and standard deviation (27.89%) for Tompkins into this regression:

PBV for Tompkins = 1.527 + 8.63(.2798) − 2.63(.2789) = 1.95

After adjusting for its higher ROE and lower risk, Tompkins still looks overvalued.

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Value Plays

Investing in financial service companies has historically been viewed as a conservative strategy for investors who wanted high dividends and preferred price stability. Investing in these firms today requires a more nuanced strategy that goes beyond looking at the dividend yield and current earnings, and looks at potential risk in these firms by examining the following.

Capitalization buffer: Most financial service firms are governed by regulatory requirements on capital. Look for firms that not only meet but also beat regulatory capital requirements.

Operating risk: Risk can vary widely across financial service firms within a sector (banks, insurance companies). Seek out firms that are operating in average risk or below average risk businesses, while generating healthy earnings.

Transparency: Transparency in reporting allows investors to make better assessments of value, and the failure to be transparent may be a deliberate attempt to hide risk. Search for firms that provide details about their operations and the risks that they may be exposed to.

Significant restrictions on new entrants into the business: High returns on equity are a key factor determining value. Look for firms that operate in profitable businesses with significant barriers to new entrants.

In summary, invest in financial service firms that not only deliver high dividends, but also generate high returns on equity from relatively safe investments. Avoid financial service firms that overreach—investing in riskier, higher growth businesses—without setting aside sufficient regulatory capital buffers.

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Aswath Damodaran, The Little Book of Valuation

Brookfield Asset Management…Q2 2021, Letter to Shareholders

Brookfield Asset Management…Q2 2021, Letter to Shareholders

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Overview

Distributable earnings grew to $1.2 billion for the second quarter of 2021. FFO was $1.6 billion and net income was $2.4 billion, all substantially higher than the second quarter of last year. We reported strong operating results, and continue to monetize assets in our capital recycling programs generating large proceeds for clients, principal investment proceeds for us, and substantial carried interests.

We have raised $24 billion of private capital since we last wrote to you, and this will continue to grow over the balance of the year as we close and launch a number of new private funds. We distributed the special Brookfield Reinsurance dividend to shareholders, recently closed the privatization of our property business, and just this week added to our insurance operations, announcing the acquisition of American National Group for approximately $5 billion.

Our financial position is very strong and our businesses are all growing as economies recover globally. This is in the context of the continuation of extremely low interest rates, which magnifies growth to the bottom line. While the threat of inflation and disinflation both loom large in peoples’ minds, we believe that the total return assets we own will perform extremely well in all environments that are expected in this cycle and beyond.

The Market Environment is Much Better

The economic backdrop has continued to strengthen over the last few months with the roll out of vaccines allowing countries to advance reopening plans. While a total reopening of the global economy will not be without challenges, we seem to be on a good path with many countries easing restrictions and others almost back to normal.

Pent-up demand has been released where allowed and this has fueled a recovery in consumption and labor markets and contributed to strong GDP growth. We are seeing this in almost all of our businesses. Inflation has predictably increased, but despite the uncertainty over the permanence of the level of inflation, the yield on the 10-year U.S. Treasury Note has settled into the low 1% range. Whether inflation will be sustained for a longer period of time or prove to be transitory, it appears certain that interest rates will be remaining “lowish” (although not quite this low) for some time.

Despite the uncertainty regarding short-term moves in interest rates and the beginning of talk of tapering, capital markets remain very constructive, with strong levels of global liquidity and a search for yield driving demand. Debt financing is available across the credit spectrum, and equity markets continue to set all-time highs. These conditions are very positive for our business, and for real assets in general. This leaves us well positioned to execute on our growth plans and deliver strong returns to our shareholders and clients.

Operating Results are Very Strong

Fee-related earnings increased by 49% to $483 million during the quarter. Distributable earnings were $1.2 billion ($0.79/share) during the quarter, or $6.3 billion ($4.05/share) over the last twelve months – the result of stable operating returns from our principal investments, carried interest realizations, and gains on the disposition of principal investments.

Realized Carried Interest Continues to Ramp Up

We realized $335 million of carried interest during the quarter as a result of several monetizations across our funds. This calendar year we have already generated over $1 billion of gross carried interest. With our asset sale program still very active, we expect the realization of carried interest to continue through the remainder of the year. We are now realizing carry within at least one fund in each of our businesses. Although carried interest is ultimately dependent on the timing of monetizations, going forward we do expect to recognize it on a more frequent and regular basis.

During the quarter we closed on the sale of a Canadian district energy company, resulting in the realization of carried interest in our first flagship infrastructure fund. Having now returned all the original capital and the investors’ preferred return, all future asset sales within this fund will result in the realization of further carry. We also realized carried interest during the quarter on the sale of two office properties in one of our more mature real estate funds; in our fourth private equity fund through secondary sales of shares of a listed company; and in our credit business which continues to monetize mature investments.

Advancing our Strategic Initiatives

Since our last reporting, we completed a number of key strategic initiatives, including the privatization of our property business and the spin-out of our paired reinsurance entity, Brookfield Asset Management Reinsurance Partners Ltd. (“Brookfield Reinsurance”). Both of these are strategically important and should be value enhancing over the longer term.

As a reminder, Brookfield Reinsurance is a paired security with BAM, meaning that it is designed to trade in tandem with the share price of BAM, while providing investors an alternative way to own BAM shares. It also provides small-cap funds an opportunity to get exposure to Brookfield. To date, the pairing has worked exceedingly well, and we feel confident it will continue to do so in the future. Brookfield Reinsurance expects the acquisition of its first reinsurance block with American Equity to close in the coming quarter and as announced earlier this week, Brookfield Reinsurance recently committed to acquire another insurance company, American National for $5.1 billion. This is the next step in Brookfield Reinsurance’s strategy.

Fundraising is Accelerating with Interest Rates Near Zero

Our asset management franchise continues to grow. We are in a period of heightened activity in our flagship funds, while simultaneously marketing a number of new funds. This should contribute to a move up to higher growth across our asset management franchise.

Closed-End Private Funds

In the last few years, we have grown our flagship funds to five – real estate, infrastructure, private equity, transition and credit. Each of these funds has a strategy centered around global themes that are driving significant capital flows and investment opportunities. In the current round of fundraising we are targeting to raise $100 billion of capital across our strategies, and our goal is to grow each of our flagship funds over time to be in excess of $25 billion.

Fundraising for our latest opportunistic credit fund is almost complete at $15 billion, the largest yet for this strategy. The fund is already 62% invested or committed, leveraging the team’s deep sourcing network and underwriting expertise to deploy capital for value. Our Global Transition Fund utilized a unique opportunity to establish a new flagship fund at large scale. The fund’s founders’ close, which took place earlier this month at $7 billion, and the establishment of a $12.5 billion hard cap, are illustrations of the opportunity we see ahead. Dealing with the issue of climate change, and deciding how it should impact investment decisions, is a top agenda item for every Chief Investment Officer allocating capital today. We expect our initial fund to be a leader in this segment and we are just getting started.

The fourth vintage of our flagship real estate fund is currently in the market, and we have already raised $9 billion in a faster and larger first close compared to the prior vintage. The final fund size is expected to exceed the $15 billion of the prior vintage. Our latest private equity flagship fund is $9 billion and is more than 75% invested or committed, meaning we will start fundraising for our sixth fund in the third quarter. Based on the success of our earlier vintage funds and the growing profile of our private equity business, we expect the successor fund to be significantly larger than the current fund. Our latest flagship infrastructure fund at $20 billion is already one of the global leaders and is currently 70% invested or committed for investment. Based on the current investment pipeline, we plan to begin fundraising for a larger successor fund later this year or early in 2022.

We also have a total of 25 mid-size private funds in the market, closed-end and perpetual, which should raise $40 billion over the next fundraising cycle; a remarkable increase compared to a few years ago. These nimble, strategic funds (each generally between $1 billion and $5 billion) are designed to cater to our clients’ needs while leveraging the broader Brookfield organization to optimize efficiency.

Perpetual Capital

Our perpetual managed capital now stands at $100 billion and has been steadily growing over the last few years – across both our listed entities and our perpetual private funds. Fee-related earnings from our listed affiliates have more than doubled over the last five years, and they continue to grow.

Our perpetual private funds are designed to provide clients with an attractive, stable return with low risk by capitalizing on the deep investing and operating expertise we have built across our main investment verticals. Some of the products include: a perpetual global super-core infrastructure fund; a perpetual real estate credit fund; and our perpetual real estate fund series, one in each of the U.S., Europe and Australia; with more to come. From a standing start just a few years ago, we now have $7 billion of capital under management from these funds.

We also continue to develop and introduce new offerings as our clients look to do more with us and as we see compelling investment opportunities in the market. This includes our recently announced private non-traded REIT, which we believe will be very additive to the franchise going forward. The flexibility added by having privatized our property portfolio will be extremely helpful in this regard.

Fundraising Channels

A key element of our growth is expanding the size and depth of our existing client relationships, while also adding new ones. Today, we have 2,000 clients, each of whom invest in 2.1 funds on average. Five years ago, we had 425 clients who were in 1.8 funds on average. This means that not only are we gaining new clients, but we are also seeing an increase in the number of Brookfield products they participate in. If we perform well and we treat our clients well, this should continue to increase.

As we scaled our franchise and product offering over the years, our fundraising efforts focused on the largest institutions across North America, Asia, the Middle East and Europe. We believe there is significant room for these relationships to grow and, at the same time, we are also focusing on new fundraising channels, including private wealth, mid-market investors and other wealth pools such as insurance.

Individual investors, supported by the wealth channel, are dramatically underweight in alternatives, often with 3% of their portfolios or less in alternatives. We recently formed Brookfield Oaktree Wealth Solutions with an initial 60 person team dedicated to growing and supporting the development of new investment structures to target wealth channels, such as our recently announced non-traded-REIT. Mid-market institutions represent a largely untapped segment of the investor market for us. Our credit platform has had considerable success in this segment, and we aim to build on that success with our other funds.

In addition, insurance companies are facing the challenge of ultra-low returns on their fixed income portfolios, and alternatives are one of the few options available through which they can aim for returns. We currently manage close to $30 billion of private fund capital from insurance companies and we expect that to grow by multiples, in particular as we continue designing regulation-friendly products for them.

The scaling of our flagship products, the diversification of our product offering, and penetration of new fundraising channels should lead to meaningful growth for our asset management franchise. This should help us achieve our target of increasing our third-party fee-bearing capital across our funds by approximately $50 billion this calendar year and for it to double over the next five years. This is in addition to our reinsurance business which we have a line of sight to at least $40 billion; and the broadening of our venture and growth investing strategies.

Real Estate Will Fuel Our Capital Plans for Years

We recently completed the acquisition of the outside interests in Brookfield Property Partners. We believe we paid our partners a fair price, and the added benefit is the flexibility to manage these assets in the private markets. In total, we now have ±$30 billion of equity invested in commercial real estate.

Approximately ±$16 billion of this equity capital is invested in an irreplaceable portfolio of high-quality mixed-use office and retail anchored properties in global gateway cities. On balance we intend to hold these assets for a very long time, if not forever. They provide an excellent total return for shareholders over the longer term, but also act as a liquidity pool for us should we ever need capital. In time, we will harvest capital with up-financings and sales of partial interests. It is likely that, unless we choose otherwise someday, the long-term permanent-hold equity will be in the range of ±$10 billion, enabling us to generate upwards of $10 billion of cash for discretionary use.

The remaining $14 billion of equity capital is invested in shorter-term opportunistic property investments, including LP commitments to our private real estate fund strategies and direct real estate holdings. Virtually all of these assets will be monetized opportunistically over the next five to seven years, with the proceeds then available to invest across the entire franchise.

Our Core Properties are comprised of ±50 assets located in 25 or so precincts in global gateway cities but centered in New York and London, both of which are exceptional global centers. These assets have proven to increase in value over the longer term, maintain high occupancy, and create numerous opportunities for us to put new capital to work at very high rates of return. The office locations are mostly the best-of-the-best in the finest cities in the world in which to own property. Our retail locations are among the most productive centers in the world — they are must-have locations for the world’s leading retailers. All of these locations are irreplaceable, and while we may have certain strategic partners to invest alongside us, we intend to maintain significant ownership interests in them and control their operations for the foreseeable future.

Our Opportunistic Properties consist of two groups of assets – fund investments and direct investments. Approximately half of our capital here is invested through our various private real estate fund strategies alongside institutional clients. These funds are global and target very high rates of return (upwards of 20% plus) across a wide range of real estate asset classes including logistics, multifamily, hospitality, student housing and life sciences, in addition to office and retail. Our capital is invested beside some of the world’s most sophisticated real estate investors, including leading sovereign wealth funds, insurance companies and public pension plans. The terms of these funds vary but are typically between seven and 10 years, creating a natural recycling of our capital with proceeds received from older vintage funds reinvested into future fund strategies.

The remainder of our Opportunistic Properties consist of direct real estate, each with a shorter-duration business plan than our Core Properties. While most are very high quality in nature, and they are mostly situated in great locations, we maximize the returns on these investments through a buy/fix/sell strategy. Some of these assets are in need of an operational turnaround, while others are driven by development or redevelopment. In all cases, they benefit from the operational capabilities of our 25,000 real estate operating professionals. As with our private fund strategies, as these business plans are executed, we will look to recycle our capital into new opportunities, in property or elsewhere, or use the proceeds to repurchase shares.

We believe that the economic recovery and ensuing real estate recovery will enable us to monetize significant capital from our property investments. With $14 billion of equity in our Opportunistic Properties, and assuming reasonable returns on this capital, we should generate over $15 billion of equity for reinvestment, even with us retaining partial stakes in a number of these properties. In addition to that $15 billion, we should generate a further $10 billion from our Core Properties while remaining in control of these assets. This circa +$25 billion of capital will fuel the next phase of growth for Brookfield.

Size and Scale Matter as We Set a Path to Decarbonize Global Business

As stakeholders around the world increasingly focus on the global imperative to decarbonize, it should come as no surprise that not only is there is a growing investment opportunity set, but also an increasing amount of capital chasing investments in renewable energy and transition. For those market participants limited to investing in de-risked assets, the current market conditions are very competitive, with prospective returns compressing into the mid-single digits. With interest rates continuing near zero, this could go even lower.

Despite this, the growth and returns earned by our renewables business have been excellent over the longer term, as we continue to focus on opportunities that leverage our global scale, operational expertise, and access to capital. In fact, as decarbonization trends accelerate, the pipeline of large-scale, value-add opportunities that favor investors with a global platform and development capabilities, continues to grow. With the recent founders’ close of $7 billion for our Global Transition Fund, the additional capital we intend to raise for this strategy, and a hard cap of $12.5 billion, we intend to meaningfully grow the capital with which to assist companies transition to net zero.

As just one example on the investment front, earlier this year, we acquired the 845-megawatt Shepherds Flat project in Oregon, one of the largest wind farms in the United States. We acquired it for $750 million of upfront equity. The project was built in 2011 and is fully contracted with a high-quality, long-term offtake. In June, we began the world’s largest wind repowering project at Shepherds Flat, which we expect to deliver in under 24 months.

The repowering project entails replacing the wind turbine hardware with longer rotors and more efficient equipment, while keeping the rest of the infrastructure unchanged. This repowering is expected to increase the facility’s production by approximately 25% annually and meaningfully extend the asset’s useful life. Furthermore, given that it costs a fraction of what a comparable greenfield project costs, and enhanced generation can support a more robust capital structure, the repowering will require no additional equity from us, while generating attractive returns. All told, this project should generate mid-to-high teen returns on our investment – much higher than where this project would sell in the open market when completed, implying potential for significant capital appreciation.

Our differentiator is that there are few investors globally with the size and capabilities to take on a project of this scale. It took $750 million of equity. It also took the operating skill to repower 320 turbines over an 18 month period. This requires intense development skills, power marketing knowledge, and operating capabilities. Our position as one of the leading renewable power platforms globally, with strong existing relationships with equipment suppliers, permitting authorities, financing partners, and power off-takers positioned us to execute this $600 million repowering.

The overall market for repowering is large and global. Within the next five years, almost 200 gigawatts of global wind capacity will be 15 years old or older. Given our global scale and extensive operational expertise, we are uniquely positioned to execute on a number of large-scale repowerings – both across our existing facilities as well as those that we acquire. These opportunities should deliver excellent returns for our investors.

American National Group Adds Meaningfully to Our Insurance Plans

Over the last 10 years, we have built a team to provide a wide range of capital and investment solutions to insurance companies around the world. This entails assisting insurers with investment management services, and providing them higher yield credit products through our funds. More recently as rates reached today’s lows, we started acquiring direct books of business reinsuring asset-intensive life and annuity policies. To focus our efforts and create a more efficient structure, we recently formed Brookfield Reinsurance, the shares of which we distributed to BAM shareholders last month.

Our partnership approach to business, our investment capabilities, strong balance sheet and significant liquidity are key differentiators, making us a good counterparty for insurers, particularly in this low-interest-rate-environment. We also have a long track record in real estate, infrastructure and other lower-volatility, higher-returning credit strategies – all of which are a strategic competitive advantage when dealing with life and annuity-focused insurance companies.

In order to augment our transaction capacity in the U.S., we announced this week an agreement through Brookfield Reinsurance to acquire a 100% interest in American National Group Inc. for $5.1 billion. American National is a 100-year-old, U.S.-based insurer that provides a wide range of insurance products, predominantly in the life and annuities space. The company has a long and stable operating history, experienced management team, and conservative culture centered around prudent underwriting, capital preservation, and balance sheet management. The company has $28 billion of assets, $22 billion of insurance liabilities, and $6 billion of book equity. Our acquisition of it significantly enhances our platform in the U.S. for further growth in the future.

Once the American National transaction closes, we will have approximately $40 billion of insurance assets under management through a combination of direct business, our pension transfers operations, and the reinsurance transactions signed to date with several U.S. insurers. These assets, when fully invested in a number of our credit strategies, should generate over $200 million in fee revenues annually. More importantly, we expect our invested principal capital in our overall insurance strategy to meet or exceed the returns on equity we have become accustomed to at Brookfield while also enabling us to get smarter about how to best meet the objectives and needs of our broad array of growing insurance clients.

Closing

We remain committed to being a world-class asset manager, and to investing capital for you and the rest of our investment partners in high-quality assets that earn solid cash returns on equity, while delivering downside protection for the capital employed. The primary objective of the company continues to be to generate increasing cash flows on a per-share basis and, as a result, higher intrinsic value per share over the longer term.

Please do not hesitate to contact us should you have suggestions, questions, comments or ideas you wish to share.

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Sincerely,

Bruce Flatt

Chief Executive Officer,

August 12, 2021