Maple Leaf Memo
Canadian Finance Minister Jim Flaherty bobbed, weaved and feinted his way from the Halloween trust tax announcement all the way through his testimony before a special hearing of the House of Commons Finance Committee. Aided and abetted by a pliant national press, the income trust tax story became one of “corporations paying their fair share” and “leveling the playing field” and other such amorphous, easily digestible memes.
The good thing is, as the great, unknown conservative thinker Richard Weaver wrote, ideas have consequences. And consequences roll particularly hard off public-policy rubbish heaps.
The good news is the stench is wafting its way up to the elite media, and it could rouse an otherwise indifferent Canadian public to the incompetence, indifference and/or inside dealings of the present minority government.
Income trusts are being sold at an increasing rate to foreigners and private equity players. Including firms already up for sale as of Oct. 31, 2006, 17 trusts have been bought or are in the process of being bought, representing a total value of CD15.2 billion. Foreign private equity accounts for about 45 percent of the deal value, with foreign corporations accounting for another 16 percent.
Fourteen business trusts, five real estate investment trusts (REITs), two power funds and one oil and gas company have announced strategic reviews, meaning they’re looking for a buyer.
Last week, KCP Income Fund became the 12th trust to be taken out since Halloween; during the first 10 months of 2006, there were nine trust takeovers. Guessing the number of deals will double during 2007 is probably as good a prognostication as anyone else’s, but suffice it to say there will be many more deals.
KCP signed a deal to sell itself to Caxton-Iseman Capital for about CD493 million, and the New York-based private equity fund will also pick up about CD311 million of debt.
KCP founder and CEO David Cynamon said the fund wouldn’t have put itself up for sale if there were no income trust tax proposal.
“The process was triggered by the Halloween announcement by the government, which forced us to look at an alternative strategic transaction of some kind knowing that there was a timeline in which not only our income trust structure would now be taxed, but for the most part the income trust playing field would be very different,” Cynamon said.
Before Halloween, income trusts allowed mid-cap businesses to stay Canadian-owned. But access to capital is now limited, and trust valuations are relatively low.
Given the amount of low-cost capital waiting on the sidelines, takeovers will continue. And don’t forget, income trusts generate strong cash flows–ideal businesses to service the debt used by private capital to finance transactions.
Flaherty, as is his way, ignored the facts.
“This is not something that has to do with a particular tax policy,” Flaherty said last week in a public appearance in support of the 2007 federal budget. “It has to do with large pools of capital that have been accumulated and are looking for purchases in various parts of the world.” On the last point, the finance minister is undeniably correct.
University of Toronto Professor of Business Economics Jack Mintz, sort of the intellectual godfather of the income trust tax, acknowledged that the proposed tax on distributions has made trusts vulnerable to takeovers but said it wasn’t necessarily a bad thing. He based this conclusion on the idea that ownership changes tend to usher in better management. Mintz noted that trusts were shielded, to some extent, from takeovers prior to the federal trust tax announcement because their relatively high market values made purchases more prohibitive.
“It allowed managers maybe to avoid the threat of takeover–and therefore encouraged inefficiency,” said Mintz told the Toronto Globe and Mail. “There’s a lot of Statistics Canada evidence now to show that even foreign companies have done a pretty good job of running Canadian companies and improving their productivity–that maybe this is all not such a negative thing after all.”
But we’re not talking about strategic players, professor, looking to maximize distribution channels or fill out a product line. These are financiers. They’re going to load up debt and use trusts’ strong cash flows to service it.
“When you are operating as an income trust and have the high valuations at that point–and the very high distributions–it made it difficult for someone to come in and do a takeover based on such a very high valuation,” Mintz said.
Let’s back up for a second: Flaherty pitched the trust tax—the Tax Fairness Plan—as a way to get back tax dollars these businesses were avoiding. But ownership by foreign capital will result in less tax revenue at the provincial and federal level. There will be no more tax revenue collected from Canadian investors paying dividend rates, private equity will load up debt on the strength of the Canadian asset base–making the operation basically nontaxable in Canada–and interest crossing the border will be free of withholding tax.
In an interview, Caxton-Iseman managing director Steven Lefkowitz said his company liked KCP’s management and its position in the marketplace. He said Caxton-Iseman doesn’t want to make any major changes at KCP.
Well, Mintz is basically acknowledging the underlying quality of the assets by suggesting “new management” rising from the private capital takeover is endemically good. But the whole reason the private capital is after the business is the strong cash flow. Ergo, good assets plus strong cash flow equals solid cost management and predictability of revenue. Doesn’t that sound like a good dividend candidate?
Does Jack Mintz think we’re idiots?
Gutting The Farm System
PricewaterhouseCoopers’ regular report on Canadian initial pulbic offering (IPO) activity suggests another negative consequence of the income trust tax proposal: total IPO proceeds of CD298 million for the first quarter off 85 percent from the CD2 billion of the first quarter of 2006.
The Toronto Stock Exchange (TSX) and the TSX Venture market saw 20 new offerings in this period, down from 34 a year ago. Five new issues worth CD191 million were listed on the TSX in the first quarter, a tenth of the CD1.9 billion in IPO activity a year earlier, when income trusts dominated new issues.
It’s the second consecutive quarter of slow activity, indicating that small Canadian companies aren’t looking to enter public markets at present.
Before Oct. 31, 2006, income trusts were attracting foreign capital to Canada; Flaherty’s proposal and dogged refusal to alter it have reversed the trend. That Flaherty doesn’t see or won’t admit to the relationship between the Conservatives’ new tax policy and the spate of foreign takeovers demonstrates either that he doesn’t know how capital markets work (and calls into question his suitability for the office), that he doesn’t care (and that he’s indifferent to mid-cap Canadian-owned business) or that he had some idea it would play out this way (and sacrificed Canadians’ nest eggs and the distribution streams of otherwise healthy business on the altar of Big Global Capital).
So he’s incompetent, indifferent or sublimely calculating. In any case, Canada’s Liberal Party should be able to make some hay out of any of these concepts.
An SES Research-Sun Media poll conducted last week indicates that, despite Stephen Harper’s attempt to spend his way to a majority, the Canadian political standings remain basically unchanged from election day 2006.
If an election were held today, the poll indicates the Conservatives would win about 36 percent, the Liberals 33 percent, the New Democrats 16 percent, the Bloc Quebecois 10 percent and the Green Party 6 percent.
Harper is still short of 40 percent, the number Canadian political junkies considered the threshold to winning a majority government.
The Liberals and Conservatives basically swapped places in the standings in Quebec, accounting for the minority government and the current order of preference.
Those who follow such things have eagerly awaited the SES Research results: The firm’s final poll before the last election was accurate to within one-tenth of a percentage point.
The biggest change for the Conservatives has been in Quebec, where they’ve jumped from 20 percent in early February to 28 percent. The CD3.4 billion in budget giveaways to Quebec in the recent Conservative budget apparently did its trick, as did Harper’s earlier recognition of the Quebecois as a “nation within Canada.”
Speaking Gigs
Take it to the mountains—that’s what we say. Join me and PF Editor Neil George and Associate Editor Elliott Gue at the 17th Annual Atlanta Investment Conference, April 19-21, at Chota Falls outside Atlanta. Go to http://www.aicatchota.com or call 678-778-8136 to register. Don’t forget to tell them I sent you.
Vegas baby! There are more reasons to go to Las Vegas than just the casinos and entertainment. Join me and PF Editor Neil George and Associate Editors Elliott Gue and Ivan Martchev at the Las Vegas Money Show, May 14-17, 2007. The conference will take place at the Mandalay Bay Resort & Casino. To register for free, go to http://www.lasvegasmoneyshow.com/MS/lasVegas?scode=008212. Let them know I sent you.
I’ll be taking to sea with PF Editor Neil George and
Associate Editor Elliott Gue on board one of Europe’s finest luxury
cruises June 14-25, 2007. The MS Deutschland will take us on a tour of
eight Northern European nations and provide you with ample opportunity
to mingle and discuss anything on your mind concerning your
portfolio–or anything else for that matter. For more information on
the cruise, contact Conlin Travel at 877-814-6502 or nycimpresario@mac.com.
The Roundup
Oil & Gas
Enterra Energy Trust (ENT.UN, NYSE: ENT) is paying CD63 million for an unnamed, privately held company active in oil and gas exploration and development in western Saskatchewan. The mystery company has current production of about 2,400 barrels of oil equivalent (BOE) per day, comprising 1,400 barrels of oil and 6 million cubic feet of natural gas, proved reserves totaling 2.94 million BOE and proved plus probable reserves totaling 4.66 million BOE. Enterra Energy Trust is a sell.
Gas/Propane
Energy Savings Income Trust (SIF.UN, ESIUF) boosted its distribution 18 percent, effective with the April 30 payment, to an annualized CD1.115 per unit, or 0.09292 cents Canadian per month. Energy Savings previously forecast 15 percent to 20 percent growth in gross margins and distributable cash for 2007.
Cold weather on the East Coast and the long-term power supply arrangement with Bruce Power LP had positive impacts, and a Canada Revenue Agency ruling allowing the fund to convert from a “trust on corporation” to a “trust on partnership” structure will minimize income taxes payable through 2010. Buy Energy Savings Income Trust up to USD15.
Business Trusts
Bell Aliant Income Fund (BA.UN, BLIAF) has competition for Amtelecom Income Fund: Independent cable-television company Bragg Communications (which operates as EastLink) last week announced a CD14.25 per unit (CD104 million) bid, topping Bell Aliant’s offer of CD13 per unit (CD95 million). Bragg, Canada’s fifth-largest cable company, has the support of Amtelecom’s trustees. Bell Aliant’s offer will expire April 13. Bell Aliant Income Fund is a buy up to USD30.
Big Rock Brewery Income Trust (BR.UN, BRBMF) boosted its distribution by 2 cents to 13 cents Canadian per month. Hold Big Rock Brewery Income Trust.
Cinram International Income Fund (CRW.UN, CRWFF) diversified into the video game world by paying $50 million for US interactive software company Ditan Corp. Cinram, which makes DVDs for Hollywood studios and others, will pay New Jersey-based Ditan an “additional cash consideration” beyond $50 million based on performance targets. Cinram International Income Fund is a hold.
Menu Foods Income Fund (MEW.UN, MNUFF), which recalled 60 million pet food cans and pouches March 16, extended the recall date to pet food made between November 8 and March 6. Menu Foods said April 5 that 20 varieties of dog and cat food had been added to the recall list. No new brands were added. The company first said the recall applied to food made as early as December 3.
The US Food and Drug Administration (FDA) said it found melamine in some of the company’s wet pet food. The FDA has traced all of the foods containing melamine, a “relatively non-toxic” substance according to the FDA, to a supply of wheat gluten obtained from China by ChemNutra of Las Vegas. ChemNutra said April 3 it had recalled its gluten. Melamine may be linked to another substance that hasn’t yet been identified that could have contributed to pet deaths, according to the FDA. Hold Menu Foods Income Fund.
Tree Island Wire Income Fund (TIL.UN, TWIRF) has agreed to acquire Baoan International Investment (BII) and Universal Metal New Material (UM) for nearly USD18.5 million. California-based BII and Hong Kong-registered UM are majority owned by the China Baoan Group.
UM owns and operates two wire products manufacturing facilities in the northern Chinese municipality of Tianjin. BII owns Universal Sourcing of America Industries, a wire products business with manufacturing in California and a liaison office in Beijing. BII and UM’s combined operations produce drawn wire, engineered mesh and other industrial wire products, exporting wire products to North American customers from China. Tree Island Wire Income Fund is a hold.
Real Estate Trusts
Chartwell Seniors Housing REIT (CSH.UN, CWSRF) has acquired 100 percent interest in a portfolio of 24 freehold and two leasehold interests in retirement communities for CD400 million from Merrill Gardens LLC. The majority of the facilities (a total of 2,374 suites) were built within the last 10 years. All but one is licensed residences, and they’re almost exclusively private pay.
The properties include seven in Florida, seven in Texas, three in Alabama, two in Arizona, two in Georgia and one each in Louisiana, Oklahoma and Tennessee. Two leased properties in Florida are also part of the deal. The acquired facilities had a combined occupancy rate of more than 95 percent for the last five years. Chartwell Seniors Housing REIT is a hold.
Natural Resources Trusts
PRT Forest Regeneration Fund (PRT.UN, PFSRF) announced that the controlling shareholder of PRT Management, the fund manager, has asked the trustees of the fund not to stand for re-election at its 2007 annual meeting. The shareholder prefers a slate that’s committed to the “growth through diversification” strategy that shareholder favors over its current direction. The trustees of the fund have therefore deferred the annual meeting until June 26, 2007. PRT Forest Regeneration Fund is a buy up to USD8.