Handling IR for a Canadian income trust is not an enviable position these days. The sector is down around 20 percent and trusts are having a hard time getting new investment following the Canadian finance minister’s surprise October 2006 decision to tax them.
‘A lot of us have retail holders, who tend to be quite expressive,’ says George Kesteven, president of the Canadian Association of Income Funds. ‘Many people have lost money so we have a number of unhappy investors,’ adds David Carey, senior vice president of capital markets for ARC Energy Trust.
These investment vehicles are now less appealing to Canadian retail investors seeking low-risk, high-yield investments. The sector was previously popular with pensioners who often relied on trust distributions to supplement their incomes. ‘Some would use this money to buy groceries or pay the phone bill,’ comments Kesteven, who also heads IR for PrimeWest Energy Trust. Now that investors will have to start paying a hefty tax rate of 31.5 percent on trust distributions from 2011, many are fleeing the sector.
ARC Energy saw trading volume double immediately following the announcement; it has only recently dropped off. Carey has, however, seen more interest from oil and gas investors who previously viewed the stock as too expensive. ‘They didn’t like the sector because they want to build returns through capital gains, and trusts are designed to return income,’ he says. ‘But the correction in price has brought more interest from traditional investors.’
Wanting in
Private equity is also buying up these downtrodden stocks. The business trust sector has seen a flurry of deals, with more expected. KCP Income Fund was recently bought by US private equity group Caxton-Iseman Capital for C$804 mn ($717 mn), while Gateway Casinos Income Fund was scooped up for C$886 mn by Australian media magnate James Packer and Macquarie Bank.
So far 19 business trusts have been sold and another 20 are reviewing strategic options, according to Kesteven. With only around 80 firms in the Canadian business trust sector, almost 40 is a significant number of deals.
There is debate about whether foreign private equity buyouts are the right outcome for income trusts. The sector blames finance minister Jim Flaherty for leaving companies no choice but to seek out buyers. ‘When we met with the minister in November, we said that because he has shaved 20 percent off value with his tax and stranded trusts from accessing capital, the best option is for them to sell at a decent premium,’ explains Kesteven.
Flaherty recently tried to defend his tax, claiming it’s not directly responsible for the rush of deals. Ironically, foreign private equity ownership prevents the government from collecting the federal taxes it intended to pick up under the new taxation rules. On the other hand, new ownership could result in better management and even better IR. ‘It is important for the strength of the Canadian economy to have foreign investors provide better access to technology and management, and possibly improve the way an operation might perform,’ says Jack Mintz, a business economics professor at the University of Toronto’s Rotman School of Management.
Income trusts were largely shielded from take-overs in the past because of their high valuations. ‘The interest from private equity might also improve IR as companies decide to boost their values for fear of private equity coming in,’ adds Mintz.
Losing trusts
Canada’s income trust sector boasts around 240 companies but that number could dwindle significantly. Many trusts are considering reverting to corporations before the tax takes effect, partly because the federal government will allow trusts to do this without a tax penalty, but also because the average corporation tax rate in Canada is 7 percent. Given the uncertainty on how the new rules will be implemented, however, most trusts aren’t yet announcing their plans.
‘We see the next four years as a tax holiday and, as we can’t predict the next six months, who is to say whether we will convert in four years?’ says Pat Marshall, vice president of communications and IR at Cineplex Entertainment. Cineplex is one of the few trusts to survive the taxation bombshell unscathed.
‘Like others, we experienced a big drop in valuation right after that horrid Halloween announcement but, within a few days, we bounced right up,’ says Marshall. She attributes this success to investors focusing on the company as a business rather than as an income trust.
Most IROs have not adjusted their strategy significantly since the announcement. ‘While we need to be aware of the tax proposal and evaluate strategic alternatives, investors don’t like to see firms get distracted by issues that are outside their control,’ explains Jordan Holm, director of IR for Boston Pizza Royalties Income Fund, which is down 20 percent since the announcement.
Others are discovering hidden talents in trying to clarify things for unit holders. ‘I have spent a lot of time explaining to US investors how our parliamentary government works,’ reports Kesteven. ‘We have a minority parliament and I joke that it has the fiscal stability of Bolivia: it is difficult to determine what it will do next.’
