Maple Leaf Memo
The 2007-08 federal budget passed in the Canadian House of Commons last night by a vote of 157-103, fulfilling a long-held expectation.
But new polling by Decima Research for the Canadian Press shows the Conservatives have fallen behind the Liberals, suggesting the skirmish over changes to Canada’s equalization formula included in the budget has hurt Prime Minister Stephen Harper and his party on a national level.
During the 2006 federal election, the Conservatives campaigned on a promise that nonrenewable resource revenue would be excluded from the formula for calculating transfers between Ottawa and the respective Atlantic provinces–so-called equalization payments.
Equalization funding is given directly to “have not” provincial governments with no strings attached to how it’s spent. It’s a program designed to ensure a relatively equal level of public services across Canada. Atlantic Canada is the region of Canada comprising four provinces located on the Atlantic coast: New Brunswick, Nova Scotia, Prince Edward Island and Newfoundland and Labrador.
The 2007 federal budget offers Nova Scotia and Newfoundland and Labrador a choice: Stick with the Atlantic Accords, or receive a larger upfront payment with a clawback of resource revenues. The Conservatives argued they kept that promise because the budget allows provinces to choose a formula that would pull nonrenewable resource revenues from equalization.
The new formula also establishes a cap on how much a province would receive as its resource revenues increase. The Atlantic Accords exclude offshore resource revenues from the equalization formula, which is used to redistribute wealth among the provinces.
Nova Scotia Member of Parliament (MP) Bill Casey was kicked out of the Conservative caucus for voting against the budget on second reading on the grounds that it violates the contractual obligations defined in the Atlantic Accords, a deal hammered out by the federal Liberal government in 2005.
In the aftermath of Casey’s ejection, Nova Scotia Premier Rodney MacDonald–also a member of the Conservative party–urged the other two Tory MPs from the Atlantic province to give their thumbs down to Bill C-52 as well. MacDonald had been working the Atlantic Accord issue behind the scenes, engaging in quiet negotiations with Harper’s government.
An open letter from Finance Minister Jim Flaherty published last weekend in Nova Scotia’s Chronicle Herald dragged MacDonald out into the open. Flaherty denied any new deal was in the works and once again claimed that Nova Scotia wasn’t being shortchanged over offshore revenues.
Newfoundland and Labrador Premier Danny Williams and Saskatchewan Premier Lorne Calvert are also unhappy with Harper over their perception that he broke another 2006 campaign promise.
Harper then challenged the aggrieved to meet him in court, literally, for a determination of whether the budget’s equalization proposals amounted to a breach of the Atlantic Accords “contract.”
The dramatic spat didn’t derail the budget, but MacDonald’s talks with the minority government appear to be ongoing. Another longer-term question is whether the internal squabbling erodes the Conservative party. Harper and the Tories have already lost ground in Atlantic Canada, provinces he carried on his way to the prime minister’s seat in 2006.
The Decima numbers suggest Harper’s dream of a majority is now lost,
and so may be his chances at holding power. The Grits are at 32
percent, the Tories at 29 percent and the New Democratic Party (NDP) at
18 percent. The Bloc Quebecois and Green Party are tied at 9 percent.
Three-week rolling averages of Decima’s weekly telephone survey put the
Liberals 6 percentage points ahead of the Tories in Atlantic Canada,
37-31, with the NDP at 20 percent and the Greens at nine. The poll also
put the Liberals ahead in Ontario, 39-33, and had the Bloc Quebecois
rebounding in Quebec to 38 percent, followed by the Liberals at 23
percent and the Conservatives at 16 percent.
Another Shoe
Turning now to an unquestionably broken promise, we’re all well aware that Harper also campaigned on a pledge to leave income trusts alone. The Tax Fairness Plan—which includes the levy on trust distributions at the entity level–was included in the ratified budget. But that story is far from over.
Steven Chase of the Toronto Globe and Mail reported this morning that a memo to Finance Dept officials dated October 30–one day before the trust tax bombshell–concluded “the income trust structure was a major impediment to private equity firms buying up pieces of Corporate Canada.”
“Private equity firms generally find it difficult to compete against the income trust alternative,” said the memo sent to Bob Hamilton, senior assistant deputy minister of tax policy at the Finance Dept. The Globe and Mail obtained the memo under access to information laws.
From today’s Globe and Mail report:
The memo, sent by Paul Berg-Dick, a director at Finance Canada, summarized a Toronto symposium on buyouts attended by a department research chief that forecast a continued hike in private equity investments.
“It is expected that large pension fund allocations to private equity will continue to increase and that small pension funds, which have shown some reservation so far, will start participating in that market as they learn from the experiences of large funds,” the memo said.
Foreign buyouts of Canadian firms were also expected to remain strong, the note said. The only obstacle to private equity buyouts of companies that was highlighted in the memo was income trusts.
It told Mr. Hamilton that trusts are considered a “serious competitor” by private equity firms because management at companies targeted for takeover prefer converting to a trust instead of succumbing to private ownership.
“When bidding for the acquisition or takeover of a Canadian company, private equity firms have to deal with the income trust factor,” it said.
“Very often, and for obvious reasons, managers will prefer the freedom of action typically associated with widely held, publicly traded entities such as trusts, as opposed to the close supervision exercised by private equity firms,” it said.
“Income trusts provide managers with a certain control over business decisions, while offering attractive valuation multiples to equity holders.”
Let’s walk the cat back on one issue the memo raises. It’s reasonable to assume that, as professionals operating within a government department nominally charged with understanding affairs of finance, the folks working for Flaherty would have some rudimentary understanding of the way key players in the private space—private equity, for example—operate.
That is private-equity firms find undervalued, cash-generating businesses, strip them down and load them up with debt. Interest expenses basically wipe out taxes owed. That’s the nutshell.
What was that about “tax leakage”?
Either the professionals have no clue about their business, or they engineered the destruction of the trust sector. Secretive, incompetent and stupid is no way to run a government.
The Roundup
In a move that could expand its range of options for dealing with the 2011 tax on trust distributions, Aggressive Portfolio recommendation Trinidad Energy Services Income Trust (TDG.UN, TDGNF) is buying assets of US-based Axxis Drilling for about USD174.8 million. Trinidad will pay USD147.3 million for the assets and has made USD27.5 million in construction commitments to finish equipment currently being built.
Axxis, operating as Drilling Productivity Realized LLC, PC Axxis LLC, DPR International LLC and DPR Rentals LLC, is selling four land-based drilling rigs and one barge drilling rig, along with a second barge drilling rig currently under construction, related inventory, crewboats and spare parts.
Trinidad expects the acquisition to be “immediately accretive on an operating cash flow per trust unit basis and provide increased business opportunities in the United States, while lowering the risk associated with Trinidad’s current United States expansion.”
The company plans to pay for the acquisition with CD145.3 million in cash and about CD29.5 million in convertible debentures. Trinidad will also raise CD325 million in a bought-deal financing, issuing 7.75 percent convertible unsecured subordinated debentures. Net proceeds will go toward funding the cash portion of the Axxis deal, to repay outstanding debt and for general working capital purposes.
The Axxis acquisition is anticipated to provide increased business opportunities in the US while lowering the risk associated with Trinidad’s current US expansion. It will also provide Trinidad with an entry into the US barge rig market with opportunities to grow in other jurisdictions.
All of the land rigs being acquired are on take-or-pay contracts until the end of December 2008. The Axxis rigs have achieved a 100 percent utilization rate since January 2004.
Foreign revenue won’t be impacted by the proposed tax on trust distributions, and Trinidad will now have significant assets that could be spun off as a US publicly traded partnership. Trinidad Energy Services Income Trust is a buy up to USD18.
Oil & Gas
Harvest Energy Trust (HTE.UN, NYSE: HTE) is buying Grand Petroleum for CD110 million (USD103.6 million) in cash to boost its oil and gas output. Harvest is offering CD3.84 a share for Grand, a 6.7 percent premium to last Friday’s closing price. Harvest will also assume Grand’s CD35 million of debt.
The acquisition will bring Harvest 3,409 barrels of oil equivalent a day from Grand’s properties in Alberta and Saskatchewan, and proved and probable reserves of 6 million barrels of oil equivalent. Grand also has 46,000 acres of exploration lands. The price tag works out to CD42,000 per barrel of daily production and CD24 per barrel of proved and probable reserves.
The acquisition, backed by Grand’s directors but pending shareholder approval, is expected to close in late July. Harvest Energy Trust is a hold.
Gas/Propane
AltaGas Income Trust (ALA.UN, ATGFF) is selling Cedar Energy Partnership to a private energy company for approximately CD12 million, effective June 1, 2007. In addition, AltaGas will receive 1 million warrants of the purchaser, each of which will allow AltaGas to subscribe for and purchase one common share in the capital of the purchaser for a three-year term ending June 1, 2010.
The noncore Cedar Energy assets were held and produced primarily to supply a long-term natural gas sales contract. In late 2006, AltaGas secured third-party supply to this long-term gas commitment, eliminating the need for the assets.
The sale allows AltaGas to focus more on its core natural gas and power businesses. It’s expected to modestly increase net income, providing approximately 1 cent Canadian per unit on an annual basis. The sale will also result in a one-time gain of approximately CD1.5 million. AltaGas is a buy up to USD26.
Wellco Energy Services Trust’s (WLL.UN, WLLUF) previously announced discussions with an unnamed potential acquirer have collapsed. Wellco said discussions with other suitors continue.
Wellco, which announced in late May that it had signed an exclusivity agreement with a potential buyer, said, “[It] is in discussions with select additional third parties regarding the potential sale or merger of the trust or other material transactions.” Wellco Energy Services Trust remains a buy up to USD8.
Business Trusts
Cinram International Income Fund (CRW.UN, CRWFF) is voluntarily filing a Form 15-F with the US Securities and Exchange Commission (SEC) to terminate the registration of its units under the Securities Exchange Act of 1934, as amended. The termination of registration will become effective 90 days after its filing with the SEC.
Cinram’s obligation to file certain reports with the SEC, including an annual report on Form 20-F and reports on Form 6-K, will immediately be suspended. Cinram will continue to meet its Canadian continuous disclosure obligations through filings with the applicable Canadian securities regulators.
Cinram’s filings can be found on the System for Electronic Document Analysis and Retrieval (SEDAR) at www.sedar.com. Cinram International Income Fund is a hold.
Menu Foods Income Fund (MEW.UN, MNUFF) reported it’s lost a “significant customer” representing 11 percent of its 2006 sales. The unnamed customer had previously put its orders for cuts and gravy product on hold but has since cancelled its contract. Menu Foods had previously lost two major contracts worth about 4.5 percent of sales last year.
The company posted a loss of CD17.5 million (92 cents Canadian per unit) for the first quarter, a sharp decline from a profit of CD1.3 million (7.3 cents Canadian per unit) in the first three months of 2006, and includes about a half-month of the recall that began March 16. Sales totaled CD64.5 million, down 31.3 percent from CD93.9 million for the same period last year.
Menu Foods estimates the recall will cost about CD45 million, excluding the impact of reduced sales or the costs of any claims or litigation that may exceed its insurance coverage. The company said previously that about 90 class-action lawsuits have been filed against it. Sell Menu Foods Income Fund.