Maple Leaf Memo
Henry Kravis is going to judge the deal on whether he cashes out–in five years, give or take–at a hefty premium and whether there’s significant global progress on fighting carbon emissions or not. To the legendary orchestrator of leveraged buyouts, it’s still about making money.
His firm, Kohlberg Kravis Roberts & Co, and David Bonderman’s Texas Pacific Group have offered USD45 billion for TXU Corp in the largest-ever private equity transaction. The offer is USD69.25 in cash per share, a 15 percent premium over TXU’s February 23 closing price. Goldman Sachs, among other Wall Street stalwarts, will take a small piece and help finance the debt. The group is assuming USD12 billion in debt.
When it first hit the wires Friday, the buyout set hearts a-racin’ because of its sheer size. Then on Sunday the New York Times reported that KKR and Texas Pacific made environmental impact a big part of the negotiations.
Eight of 11 proposed coal-fired plants in Texas will be scrapped under terms of the deal, as the prospective new owners sought relief from local and national opposition.
Private equity actually consulted–at the behest of Goldman Sachs–environmental groups to gauge their concern and solicit their opinion on the deal. What happened during the takeover negotiations provides more evidence that global financial and political heavyweights realize that something has to be done, soon, to combat climate change.
Times reporter Andrew Ross Sorkin tells a story worthy of Woodward for the names dropped (there’s Kravis, of course, and former Bush I Environment Protection Agency Administrator William K. Reilly, and current Treasury Secretary Henry Paulson and…James Baker):
Early Monday, after several weeks of marathon negotiations that brought together both environmentalists and Wall Street bankers, TXU announced that its board of directors had approved the bid from Kohlberg Kravis and Texas Pacific for about $45 billion, which would be the largest buyout in history.The deal was noteworthy not just for its size, but for the confluence of business decisions and environmental concerns that drove the ultimate transaction. Because private equity firms are unregulated and historically have valued their privacy, neither Kohlberg Kravis nor Texas Pacific were eager to become an “enemy combatant” of the environmental groups, people involved in the talks said. Reducing the coal plant initiative will also free up billions of dollars in planned spending that the firms will be able to use for other projects or to help finance the transaction.
Within TXU, the controversial plan to build a raft of coal plants had become so damaging to its stock price that its board had been privately weighing a plan to scrap part of the project, said people involved in the talks, bringing the number of new plants to 5 or 6 from 11. Shareholders had sent the stock on a roller coaster ride from more than $67 a share to as low as about $53 over concerns about the risk and vast expenditure; the stock closed at $60.02 on Friday.
Indeed, it was the quick drop in TXU’s stock price that got the attention of Kohlberg Kravis and Texas Pacific, which look for undervalued companies and try to turn them around. Together, both firms approached C. John Wilder, TXU’s chief executive, in January with an offer for the company, these people said.
At the time, neither Kohlberg Kravis nor Texas Pacific told TXU about their ambition to scale back its controversial coal plants. But behind the scenes, both firms had been developing a new strategy for the company with the help of Goldman Sachs, their lead adviser.
Goldman Sachs has been a longtime proponent of reducing carbon emissions. Its former chief executive, Henry M. Paulson, now the secretary of the treasury, was also the chairman of the Nature Conservancy, an environmental activist group.
Texas Pacific’s co-founder, David Bonderman, is member of the board of the World Wildlife Fund, and Mr. Reilly is chairman emeritus. Mr. Bonderman called Mr. Reilly to help work on the deal and create what they ultimately called The Green Group, a committee of advisers that included Mr. Reilly, Roger Ballentine of Green Strategies and Stuart E. Eizenstat, the former chief domestic policy adviser for President Jimmy Carter.
“We didn’t want to be on the wrong side of history,” said a person involved in the bidding group who was not authorized to talk about the transaction before its formal announcement.
Who knows how this will work out for KKR and Texas Pacific. The actual impact of the plant cancellations won’t be felt for years; those eight weren’t scheduled to break ground for several years yet. And there’s still considerable opposition to the three plants that will, as of now, proceed.
But the biggest leveraged buyout ever is also the latest reminder of an emerging consensus on climate change.
“We didn’t want to be on the wrong side of history.”
Tremors Across The Border
As discussed in the February 2007 Canadian Edge feature article, a great many income trusts will draw the attention of cash flow-hungry private equity funds. The S&P/Toronto Stock Exchange Composite Index turned in a record close for the seventh time in the last nine trading sessions on growing speculation that there will be more takeovers. Canadian stocks of every stripe shot up Monday on news of the TXU buyout.
Private firms completed acquisitions worth a total of more than USD700 billion in 2005. The value of deals involving Canadian companies rose 55 percent in 2006 to CD257 billion (USD222 billion), up from CD165 billion in 2005.
Borrowing costs are low, there’s a lot of money out there looking for assets to buy, and Canadian companies are cheaper than US companies: The S&P/TSX trades at a price-to-earnings (P/E) ratio of 16.8 percent, compared to the S&P 500’s 17.8 percent.
Credit Suisse estimates that buyout funds are sitting on USD1.3 trillion, looking for places to play. The pace is picking up, and the deals are getting bigger.
The characteristics that define good trusts–steady cash flow, relatively low capital spending–make them solid takeover candidates. Private-equity funds build balance sheets with more debt and less equity than traditional companies, and they look for steady cash generation, low debt and cheap assets.
Precision Drilling surged 1.85 percent in the wake of the TXU deal, but it was making headlines even before the announcement.
After a recent distribution cut–dictated by the slide in natural gas prices and subsequent cutback in activity–Precision Drilling is 34 percent off its recent high. But its Monday spike reflects its solid cash flow, manageable debt and attractively valued assets in the form of solid relationships in the oil and gas industry. These are things private equity is after.
Boralex Power is similarly undervalued, selling for 1.24 times the equity value of its fleet of hydro, cogeneration and wood waste power plants. The power generator operates under long-term contracts with stable pricing and has limited fuel cost exposure.
Newalta Income Fund has been growing sales at a compound rate of more than 30 percent a year for more than a decade, but nonetheless it sells for just two times sales and twice book value. It, too, rode the TXU news higher Monday.
The RoundupWe’re in the process of compiling tax information for US-based Canadian income trust unitholders and will have a full report in Canadian Currents in the March issue of CE, to be delivered to your inbox March 9.
Here’s the roundup.
Oil & Gas Trusts
ARC Energy Trust (AET.UN, AETUF) reported a 56.6 percent drop in fourth quarter profits–from CD130.5 million in 2005 to CD56.6 million–on a 19.9 percent fall in revenue. Revenue was down to CD292.5 million from CD363.5 million a year ago. For 2006, ARC generated revenue of CD1.23 billion and a profit of CD460.1 million, up 28.9 percent from CD356.9 million in 2005. The company spent CD365 million on exploration and development, adding 16 million barrels of oil equivalent (boe) and replacing 71 percent of 2006 production.
Production guidance for 2007 will be 63,000 barrels of oil per day. In accordance with the requirements of Canada’s National Instrument 51-101, ARC reported a proved reserve life index (RLI) of 9.8 years based on 2007 production guidance of 63,000 boe per day. The trust replaced 96 percent of annual production at a finding, development and acquisition (FD&A) cost of CD22.41 per boe. Reserves per trust unit decreased slightly from 2005 to 2006 from 1.42 to 1.38 boe per unit on a proved plus probable basis and from 1.13 to 1.09 boe per unit on a proved basis. ARC’s 2006 year-end reserves are within 1 percent of year-end 2005 levels with proved reserves of 226 million boe and proved plus probable reserves of 286 million boe. ARC Energy Trust is a buy up to USD22.
Enerplus Resources (ERF.UN, NYSE: ERF) experienced an 11 percent boost in cash flow for 2006, from CD774.6 million to CD863.7 million. Net income increased 26 percent to CD544.8 million, or 13 percent to CD4.48 per trust unit. Cash distributions increased in 2006 by 23 percent to CD614.3 million, or 11 percent per unit compared to 2005. Fourth quarter profits dipped to CD110.2 million from CD150.9 million for the same 2005 period as sales revenue fell on declining oil and gas prices.
Enerplus maintained a healthy 71 percent payout ratio. According to its required public disclosure, the trust sports one of the longest RLIs in the sector at 14 years on a proved plus probable basis; on a proved basis, RLI is 10.1 years. FD&A costs for 2006 stood at CD23.19 per boe on a proved plus probable basis and CD28.82 per boe on a proved basis. Operating costs averaged CD8.02 per boe. Enerplus’ net debt to trailing 12-month cash flow ratio of 0.8 times reflects management’s conservative style. Buy Enerplus Resources up to USD50.
PrimeWest Energy Trust (PWI.UN, NYSE: PWI) reported earnings per unit for the fourth quarter of CD1, down from CD1.56 in 2005 on lower natural gas prices. For the full year, net income rose to CD208.3 million from CD207.5 million. Revenues from commodity sales were CD690.2 million, down from CD792.6 million. PrimeWest remains tied to the course of natural gas prices in 2007; the company warned that, if prices continue to deteriorate this year, income will suffer.
Approximately 68 percent of PrimeWest’s production is natural gas. Distributions for 2006 amounted to CD3.75 per unit for a payout ratio of 84 percent; that figure is up substantially from 2005’s 68 percent. PrimeWest added 23.2 million boe of proved plus probable reserves at an average of CD11.22 per boe during 2006; the trust’s capital development program replaced 162 percent of 2006 production on a proved plus probable basis. PrimeWest’s RLI as of the end of 2006 was 13.4 years on a proved plus probable basis. Net debt to annualized 2006 funds flow from operations was approximately 2.3 times at Dec. 31, 2006, up from 0.8 times for 2005. Sell PrimeWest Energy Trust.
Sound Energy Trust (SND.UN, SNDFF) slashed its distribution by 45 percent because of the impact of falling natural gas prices on its financial performance. Management aims to return the trust to a 51 percent payout ratio. Sound also recently completed its year-end reserve study, reporting a 40 percent increase in total proved plus probable reserves during 2006 from 23.6 million boe to 33 million.
Total proved reserves increased from 16.2 million boe to 20.5 million, a 27 percent increase. Based on current production of approximately 10,500 boe per day and proved plus probable reserves of 33 million boe, Sound’s RLI is 8.6 years, up 16 percent from a year ago. Sell Sound Energy Trust.
True Energy Trust’s (TUI.UN, TUIJF) 2006 year-end reserves report revealed that True’s proved plus probable reserves increased 61 percent from year-end 2005. Natural gas makes up 62 percent, heavy oil 27 percent and light oil and natural gas liquids 11 percent. True’s average production for 2006 is estimated to be 13,861 boe per day, weighted 62 percent toward natural gas, 26 percent toward heavy oil with 12 percent light oil and natural gas liquids. Proved and probable working interest reserve additions in 2006 replaced production by approximately 4.6 times. True’s total proved reserves increased 68 percent during 2006. Sell True Energy Trust.
Vault Energy Trust (VNG.UN, VNGFF) reported year-end proved plus probable reserves of 27.46 million boe, within 3 percent of year-end 2005 numbers. The trust added 1.86 million boe proved and 1.92 million boe proved plus probable reserves during 2006 for a 68 percent replacement of proved reserves and a 70 percent replacement of proved plus probable reserves.
Vault’s proved FD&A costs and proved plus probable FD&A costs were CD22.96 per boe and CD22.97 per boe, respectively. Vault’s production guidance for 2007 remains 7,000 to 7,200 boe per day. Vault Energy Trust is a sell.
Zargon Energy Trust (ZAR.UN, ZARFF) replaced approximately 122 percent of reserves, taking its year-end reserve estimate to 27.46 million boe. Reserves per trust unit remained constant compared to the prior year at 1.41 boe per unit on a proved and proved plus probable reserves basis. Zargon registered FD&A costs of CD16.85 per boe.
Proved and probable RLI was nine years, compared to 8.5 in 2005; proved RLI for 2006 was 6.2 years, up from 6.1. Zargon drilled 76.2 net wells with a 95 percent success rate, while annual production was up 1 percent from 2005 at 8,422 boe per day. Fourth quarter output fell 2 percent short of a November forecast of 8,500 boe per day, averaging 8,366 boe. Zargon said first quarter production should meet expectations. Buy Zargon Energy Trust up to USD23.
Electric Power
Algonquin Power Income Fund (APF.UN, AGQNF) has offered CD207.8 million (USD179.3 million) in cash and stock for Clean Power Income Fund (CLE.UN, CEANF). The proposal is for 0.6152 per share and 27 cents Canadian in cash for each Clean Power share held. Clean Power has a total capacity of 303 megawatts from 15 generating plants spread across Quebec, Ontario, Alberta, British Columbia and four US states. Clean Power’s four hydroelectric sites in Ontario and British Columbia are similar to Algonquin’s facilities; the acquisition also includes a biomass facility in Alberta, not far from Algonquin’s existing biomass operation.
Algonquin likewise stands to be Canada’s largest wind power producer with the addition of Clean Power’s project in Lake Erie. Algonquin has 47 hydroelectric facilities, five natural gas-fired cogeneration plants, 17 alternative-fuel installations and 17 water supply and waste-water facilities. The Clean Power assets are also relatively young and will provide Algonquin with significant tax depreciation down the road, well beyond 2011.
The offer values each Clean Power unit at CD5.88, based on Algonquin’s Monday closing price of CD9.05 and 27 cents Canadian in cash. Clean Power’s board of trustees has recommended acceptance of the deal. Buy Algonquin Power Income Fund up to USD9; hold Clean Power Income Fund.
Boralex Power Income Fund (BPT.UN, BLXJF) reported best-ever net income of CD34 million, up 40 percent from CD24.3 million in 2005. Revenue from energy sales rose to CD115.2 million, compared to CD107.9 million a year earlier. Annual power generation by Boralex’s seven hydroelectric facilities was 22.3 percent above the historical average, driving a 12.7 percent rise in revenue from that segment.
The fund generated distributable cash of CD57 million and distributed CD53.2 million, for a payout ratio of 93 percent. Fourth quarter revenue slipped to CD30 million from CD30.4 million, and net earnings declined to CD7.4 million, or 12 cents per unit, from CD8.8 million, or 15 cents Canadian per unit. Buy Boralex Power Income Fund up to USD9.
Business Trusts
Bell Aliant Income Fund (BA.UN, BLIAF) is using the proceeds from the sale of Aliant Directory Services to Yellow Pages Income Fund (YLO.UN, YLWPF) to fund a 10 percent stock buyback. The regional landline operator is also floating CD1 billion in medium-term debt in three tranches: CD400 million of seven-year notes with a 4.95 percent coupon, CD300 million of 12-year notes bearing 5.52 percent and CD300 million at 30 years and 6.17 percent.
Proceeds from the new issues will first be used to pay down a CD3.5 billion unsecured line of credit; any residue will be devoted to operations, acquisitions or facility upgrades. Bell Aliant forecast steady 2007 revenue of CD3.33 billion to CD3.4 billion. Buy Bell Aliant Income Fund up to USD30.
Real Estate Trusts
Canadian Apartment REIT (CAR.UN, CDPYF) reported a 7.5 percent boost in operating revenue for the fourth quarter, to CD73 million, and a 9.7 percent rise to CD283.7 million for 2006. Revenue growth derived mainly from acquisitions, a stable occupancy rate and higher average monthly rents across the real estate investment trust’s (REIT) portfolio. Net operating income for the fourth quarter and year ended Dec. 31, 2006, rose 9.6 percent to CD37.2 million and 10.5 percent to CD147.3 million, respectively. Funds from operations (FFO) in the fourth quarter of 2006 increased 9.9 percent to CD16.4 million from CD14.9 million.
For 2006, FFO rose 6.7 percent to CD65.4 million, up from CD61.4 million. Distributable income (DI) increased 10 percent in the fourth quarter to CD16.4 million, or 27.8 cents Canadian per unit, compared to CD14.9 million, or 26.8 cents Canadian per unit, during the fourth quarter of 2005. For 2006, DI rose 7 percent to CD66.2 million, or CD1.170 per unit, up from CD61.8 million, or CD1.161 per unit, in 2005. Total debt (including borrowings on acquisition and operating facilities) to gross book value was 61.6 percent at the end of 2006, down from 62.7 percent. Canadian Apartment REIT is a buy up to USD18.
Dundee REIT (D.UN, DUNTF) posted a 64 percent rise in FFO for the fourth quarter to CD29.2 million. Rental property revenue improved 36 percent to CD82 million, while net operating income (NOI) was up 45 percent to CD46.3 million. Dundee’s occupancy rate at the end of 2006 stood at 96.4 percent. The balance sheet reflected the operational success, as debt-to-gross book value was down to 50.6 percent.
NOI increased by 39 percent for 2006 and FFO grew by 47 percent to 97.3 million for the 12-month period. Acquisitions contributed CD17.8 million and CD52.4 million to NOI for the quarter and year, respectively, and rising occupancy and rental rates also contributed to growth. Dundee closed CD103.3 million in acquisitions during the fourth quarter and CD598.5 million for 2006; CD125.4 million in acquisitions have closed thus far in 2007 with another CD424.3 million pending. Buy Dundee REIT up to USD32.
Legacy Hotels REIT’s (LGY.UN, LEGYF) September 2006 acquisition of the 398-room Delta Bow Valley Hotel drove a 5 percent rise in fourth quarter revenue and a 16.7 percent boost to FFO. Annual revenue increased CD44.2 million, or 5.7 percent, to CD816.7 million. Distributable income grew by more than 60 percent at 42 cents Canadian per unit. This compares to annual distributions declared of 32 cents Canadian per unit representing a payout ratio of 76 percent of distributable income. Legacy Hotels announced in February that it would acquire the outstanding interest in the Delta Beausejour Hotel for approximately CD21.2 million, combining its existing leasehold interest in the property. Hold Legacy Hotels REIT.