Maple Leaf Memo
Some will reconvert, some will be acquired, some will go private, and some will continue to operate their businesses.
There were many stories to tell before Oct. 31, 2006, and there will be many more to tell through 2011 and beyond. The elephant in the room is taxation, but that aside, we’re still talking about going concerns here. The decision-making process for trust management teams is obviously more complicated now, but you can generally say they’ll eventually fall into one of the “somes” above.
We’ve seen a spate of deals in recent weeks, with rumors of more buoying a Bay Street previously dispirited by Flaherty’s derailment of the trust conversion gravy train. There’s a lot of noise about what each deal or series of deals or rumors of deals mean for the life of the income trust universe. Will it contract? Yes. Will it implode? No.
As it is when making an investment decision, the merit or meaning of any deal can best be understood on a case-by-case basis.
True Energy Trust announced that it was converting back to the corporate form and slashed its distribution from 12 cents Canadian to a new quarterly rate of just 2 cents Canadian a share. True’s move is the first reconversion by an oil and gas trust since the minority Conservative government’s tax proposal. Management attributed the dividend cut to the new tax proposal, but reality says it was too small and weak to survive as a trust.
Bay Street firms touted it, but True’s shares tumbled for many months before Halloween. It had already cut its distribution, and more cuts were on the way. Rather than continue to pay out cash it desperately needed to function, management decided to convert back to a junior oil and gas producer or, in its words, “a growth-oriented E&P company.”
Whether it succeeds or not in its new form will depend to a large extent on what happens to energy prices. Converting will buy it more time and should enable it to survive when oil and gas prices rebound, but True had no other choice but to get a trim and go corporate.
Rain Commodities Limited, an Indian company listed on the Bombay Stock Exchange, offered CD437 million for the 80 percent of Great Lakes Carbon Income Fund it doesn’t already own. Great Lakes Carbon holds a 74 percent interest in Great Lakes Carbon USA, the world’s largest producer of anode and industrial grade calcined petroleum coke (CPC), used in producing aluminum and industrial materials.
Rain’s business consists entirely of holding investments, principally in the cement industry. But an affiliate, Rain Calcining Limited, is Asia’s largest producer of anode and industrial grade CPC. Some Great Lakes unitholders have grumbled that the 9 percent premium is still below the trust’s 52-week high, but Rain could have had it cheaper, even before Flaherty’s tax announcement.
This deal simply makes great business sense for Rain. Aluminum smelters require highly specified types of CPC to get the quality of product they want; they come to rely on and build relationships with suppliers that can last for decades. Rain wanted Great Lakes’ client base.
Calpine Power Income Fund was at the center of a late-developing, short-lived bidding skirmish between eventual winner Harbinger Capital and Khanjee Power Generation LLC, an affiliate of Khanjee Holding. Khanjee Holding is a US holding company set up in 2001 by Akhtar Ali Khan, who built his wealth on business activities in the Middle East and Asia.
Harbinger’s CD13 per unit bid was endorsed by the Calpine board January 29 after its initial offer of CD12.25 was rejected. Khanjee’s proposed alternative transaction was disclosed in a notice of motion and affidavit filed in the Alberta Court of Queen’s Bench, which had already approved the Harbinger offer. Khanjee subsequently withdrew its proposal and has discontinued pursuit of the fund.
Harbinger’s original offer was about 20 percent above Calpine’s pre-deal price, which was already well off the lows on a combination of good fundamentals news and takeover speculation. And the units ran to a point where Harbinger had to cough up a better offer. In the end, Calpine unitholders are cashing out above the fund’s prior all-time high and further above where the shares stood at the close on October 31.
Deep-pocketed private capital investors will be increasingly attracted to cash-generating assets.
While True Energy provides a textbook example of an exit strategy premised on a tax loophole gone awry, Penn West Energy Trust continues to chug along.
Penn West is paying CD339 million (USD288 million) to acquire Alberta oil and gas properties near its existing holdings in Alberta that are producing about 4,900 barrels of oil equivalent a day (boe/d). The purchase, which includes 190,000 acres of exploration lands and processing plants, is slated to close in March.
About 3,000 barrels of oil and 6 million cubic feet of gas a day of output is located in or near Penn West’s Peace River, Alberta, oil sands project or adjacent holdings in the Red Earth-Utikuma area. The assets include about 190,000 net acres of undeveloped land. Based on current production, Penn West pegged the value of the acquisition at CD61,500 per daily flowing barrel of production.
Meanwhile, the company also said that it plans to spend CD100 million on its Peace River oil sands properties in 2007, drilling 60 to 65 wells. Output there is expected to be 4,500 to 5,000 barrels a day by the spring.
Penn West was and is a good income trust because it’s conservatively managed with a focus on sustainability. Management continues to grow the business through solid acquisitions and effective cost management. It’s put itself in a flexible position, able to ride out the trust tax political storm and make use of as much of the existing grace period as possible.
And it seems to defy the whole “income trusts hurt growth” argument, huh?
For an in-depth look at deal-making in the income trust sector–including potential targets–see the feature article “True Value” in the February issue of Canadian Edge, now available at www.canadianedge.com.
Back In The Saddle
The House of Commons Finance Committee is holding one more session on the trust tax issue to hear testimony from Dennis Bruce, principal economist at HLB Decision Economics. Bruce has previously worked with the Dept of Finance Canada in developing a model to determine the lost revenue from trusts.
Members of the committee aren’t satisfied with the information they’ve received from Finance Minister Jim Flaherty. On Feb. 1, 2007, members of the Finance Committee passed a motion, which read: “That the Department of Finance provide the Standing Committee on Finance, not later than 11:00 a.m. on Tuesday, February 6, 2007, all documents and information used to justify the government’s decision to tax income trusts, as announced on October 31, 2006.”
The majority of the information provided consists of 68 submissions that the Dept of Finance Canada received from the public after the decision had been announced. The remainder consists of various private-sector studies that were publicly available prior to the announcement, as well as Flaherty’s own press releases and his speech to the Finance Committee.
Liberal Finance Critic John McCallum described the disclosure as an affront to accountability.
Bruce has said that the department is “sharply overstating” the tax leakage from trusts. A past HLB study found that federal tax revenues from income trusts are higher than those from corporations.
His testimony should be interesting; we’ll keep you posted.
The RoundupGood trusts are separating themselves from the field, the bad are hobbling along, and the ugly are smoking on the roadside.
Recent changes to the CE Portfolio seem to have furthered the mission of identifying solid businesses capable of paying sustainable dividends. Non-hackers have cut payouts and watched their unit prices tumble. Stronger trusts have also had to make tough choices, but the market has offered at least this early assessment: All Portfolio recommendations were up during the past month in US dollar terms, despite some weakness in the Canadian dollar.
Gains will come faster if Ottawa tweaks trust taxation, but good businesses will keep putting up big returns well past 2011.
Oil & Gas Trusts
Bonterra Energy Income Trust (BNE.UN, BNEUF) cut its distribution to unitholders by 8 percent because of lower commodity prices and the potential impact from new federal tax laws on income trusts. The oil and gas firm said it will cut its payout to 22 cents Canadian a unit from 24 cents Canadian and will reduce its capital expenditures for 2007 to about CD20 million from CD37 million in 2006.
The trust should continue to maintain its current production of 4,400 boe/d. Bonterra generates significant cash flow, its 10-year development inventory is solid, and there’s decent potential to boost production at the Pembina field. Bonterra units are off by 35 percent since the trust tax announcement–the second-largest decline in the sector and above the 21 percent group average. Hold Bonterra Energy.
Crescent Point Energy Trust (CPG.UN, CPGCF) closed the previously announced plan of arrangement with Mission Oil & Gas. Under the plan, each issued and outstanding Mission common share was exchanged for 0.695 units of Crescent Point Energy Trust plus cash in the amount of 78 cents Canadian. Currently, Mission’s production is in excess of 7,000 boe/d with more than 5,000 boe/d of Mission’s production from the exciting Viewfield Bakken resource play in the heart of Crescent Point’s core southeast Saskatchewan operating area.
The Viewfield Bakken pool is the fifth-largest light oil pool discovered in western Canada, containing an estimated 1 billion barrels of original oil in place. The completion of the plan increases the trust’s resource base to more than 2.5 billion barrels of original oil in place and adds more than 900 (570 net) low-risk development drilling locations. Management expects this resource base to extend Crescent Point’s drilling inventory to more than six years. Crescent Point Energy Trust is a sell.
Thunder Energy Trust (THY.UN, THYFF) cut its monthly distribution by 25 percent in light of volatile commodity prices and the dramatic drop in stock markets after Ottawa’s decision to tax income trusts. The trust set its monthly distribution at 9 cents Canadian per unit, down 3 cents Canadian. It’s to be paid on March 15. Sell Thunder Energy Trust.
Vermilion Energy Trust’s (VET.UN, VETMF) 45.4 percent-owned subsidiary Verenex Energy has made its first oil discovery at a well in the Ghadames Basin of Libya, one of a number of exploration blocks it was awarded in 2005. The Calgary-based company said test drilling to well A1-47/02 in Area 47 returned “significant oil rates.” At a depth of about 3,000 meters, the well flowed at a rate of 5,172 barrels of oil per day through a 3/4-inch choke at a wellhead pressure of 1,221 pounds per square inch over a three-hour period. Oil discovered during the test rated as light sweet crude. Further testing is under way at the site. Buy Vermilion Energy Trust up to USD30.
Electric Power
Countryside Power (COU.UN, COUUF) has put itself up for sale in the wake of the Canadian federal government’s proposal to tax income trusts and the bankruptcy of a US company that owed it USD90 million. Countryside may seek a buyer, convert to a corporate structure or recapitalize. And it’s hired Lehman Brothers to explore such strategic alternatives to boost shareholder value. A US bankruptcy court recently approved a deal between US Energy Biogas and Countryside to allow Countryside a secured claim of about USD99 million in Biogas’ Chapter 11 case. As part of the deal, Countryside gave up its 2004 royalty claim agreement with Biogas. In return, Biogas is to pay Countryside USD30 million in cash by March 31 with the balance due by the end of May. Now Countryside must decide what to do with the money from Biogas. Sell Countryside Power.
Great Lakes Hydro Income Fund (GLH.UN, GLHIF) said fourth quarter profits rose slightly to CD17.3 million from CD17 million a year ago, boosted by favorable water conditions in Quebec and New England that helped the hydroelectric power producer generate more electricity. The fund reported its income before noncash and special items amounted to 36 cents Canadian per share for the three months ended December 31, up from 35 cents Canadian a year ago. Sales rose to CD42 million from CD39.2 million, while fourth quarter power generation increased to 968 gigawatt hours from 880 gigawatt hours a year earlier. For the year, income rose to CD82.6 million (CD1.71 per unit) from CD69.5 million (CD1.44 per unit) a year ago. Sales rose to CD177.1 million from CD154.5 million. Buy Great Lakes Hydro Income Fund up to USD16.
Gas/Propane
Energy Savings Income Fund (SIF.UN, ESIUF) missed customer growth targets in its third quarter, but it managed to boost sales by more than 25 percent. Sales rose to CD417.2 million from CD328.6 million during the same quarter a year ago, thanks to a larger customer base and higher selling prices. The fund also announced it will increase its distributions to unitholders, effective in March, 3 cents Canadian to CD1.065 per unit on an annualized basis, or to 8.875 cents Canadian per month.
However, the fund reported difficulty attracting new customers and reported lower-than-expected additions to its customer base. Part of the problem was due to difficulty in finding new and replacement sales agents in Canada. Management has reduced its customer aggregation target from 475,000 down to 350,000 for the fiscal year. Energy Savings is also reviewing restructuring options in light of Ottawa’s plan to tax income trust distributions. Buy Energy Savings Income Fund up to USD15.
Business Trusts
A&W Revenue Royalties Income Fund (AW.UN, AWRRF) reported a 30 percent increase in fourth quarter profit compared with a year ago, helped by increasing same-store sales and more hamburger restaurants included in the royalty pool. The fund earned CD4.4 million, or 52.2 cents Canadian per unit, for the three months ended December 31. That compared with a profit of CD3.3 million, or 40.1 cents Canadian per unit, in the same period a year ago.
Quarterly sales at the restaurants included in the royalty pool increased to CD191.5 million, up from CD173.4 million in the fourth quarter of 2005. Same-store sales in the quarter increased 6.2 percent, while the number of restaurants in the pool increased to 654 from 638 a year ago. For the full year, the fund reported a profit of CD11 million, or CD1.32 per unit, on sales at the restaurants included in the pool of CD598.6 million. That compared with a profit of CD9.4 million, or CD1.13 per unit, on sales of CD538.7 million in 2005.
Same-store sales for the year were up 7.4 percent. The fund also announced a special distribution of 8 cents Canadian per unit in addition to its regular monthly distribution of 10 cents Canadian per unit. The extra cash will be to be paid to unitholders of record at the close of business on February 15. Hold A&W Revenue Royalties Income Fund.
Boston Pizza Royalties Income Fund (BPF.UN, BPZZF) reported an annual profit of CD14 million, up from CD11.5 million in the prior year, and the restaurant company boosted its monthly distribution by 1.8 percent. The Vancouver-based fund said its earnings amounted to CD1.30 per unit, compared with CD1.20 per unit in 2005. Boston Pizza opened more restaurants and served more customers than any other single year in its operating history.
Same-store sales grew 8.4 percent for the year. The company’s operating segment, Boston Pizza International, opened 41 new restaurants across Canada and closed one full-service restaurant, bringing its royalty pool to 266 restaurants at year’s end. The declared distributions for 2006 of CD14 million (CD1.28 per unit) compared to CD11.4 million (CD1.19 per unit) in 2005. The new monthly distribution will be 11.1 cents Canadian per unit, up from 10.9 cents Canadian. Hold Boston Pizza Royalties Income Fund.
CI Financial Income Fund (CIX.UN, CIXUF) won a takeover battle for Rockwater Capital Corp with a CD251 million offer. CI Financial, Canada’s third-largest investment fund company, will offer CD7.65 for each share of Rockwater, a Canadian asset management, investment advice and brokerage firm. Rockwater shareholders can opt to be paid in cash or in units of CI. The acquisition boosts CI’s distribution network and provides an avenue into the brokerage business through Rockwater’s Blackmont Capital unit. The deal, which requires the backing of two-thirds of Rockwater’s shareholders, is expected to close in late March. The deal’s size–just 2.3 percent of CI’s CD8.4 billion market cap as of October 31–shouldn’t inhibit CI’s future acquisition or growth plans. Hold CI Financial Income Fund.
Great Lakes Carbon Income Fund (GLC.UN, GLCIF) has received a CD437 million offer from Rain Commodities to acquire the remaining 80 percent of the coke producer that it doesn’t already own. Rain is bidding CD11.60 per unit for the Toronto-based fund, which holds a 74 percent interest in Great Lakes Carbon USA, the world’s largest producer of anode and industrial grade calcined petroleum coke, used in producing aluminum and industrial materials. Discussions between Great Lakes Carbon and Rain have been public since last October, when Great Lakes confirmed rumors that both sides were talking.
In March, Rain purchased a near 20 percent interest in the company from American Industrial Partners Capital Fund II for about CD11.99 per unit. Rain’s offer carries a break fee of CD14.5 million payable to Rain if another offer is accepted. It follows a review of the trust’s alternatives for maximizing unitholder value. Both companies target a closing date at the end of the first quarter, subject to approval by two-thirds of Great Lakes Carbon unitholders. Great Lakes, which reports in US dollars, posted a third quarter profit of USD8.8 million, compared to USD3.2 million a year earlier. Sales for the period were USD117 million, up from USD104.3 million. Hold Great Lakes Carbon Income Fund.
Pipeline Trusts
Pembina Pipeline Income Fund (PIF.UN, PMBIF) reported that fourth quarter revenue was up 13.4 percent from a year earlier at CD88.1 million and net operating profits rose 13 percent to CD55.6 million. Pembina said the year’s net operating was CD216.8 million. Pembina, which has a network of conventional feeder pipelines and a growing presence in oil sands infrastructure and in midstream terminal, storage and hub services, said fourth quarter volume averaged 846,800 barrels per day. Capital spending was CD66.7 million, up from CD27 million in the year-ago quarter, and was up 112.5 percent for the full year at CD168.9 million. Buy Pembina Pipeline Income Fund up to USD16.
Real Estate Trusts
Canadian Apartment REIT (CAR.UN, CDPYF) is expanding its Quebec portfolio with the acquisition of 17 luxury apartment buildings in Quebec City and its suburbs for CD60 million. The real estate investment trust (REIT) acquired the portfolio from Beaudet & Saucier, the Quebec City, Quebec-based builder of the developments. Prior to the February 1 closing on the transaction, CAP REIT arranged new 10-year fixed-rate financing of approximately CD39.3 million at an interest rate of 4.71 percent. Overall occupancy in the 607-suite portfolio is 98 percent.
The REIT now owns 5,373 suites in the province of Quebec, representing about 20 percent of CAP REIT’s portfolio. The remainder of the REIT’s portfolio is about 70 percent in its home base of Ontario with the remaining 10 percent scattered across the continent from coast to coast. Rents in the Quebec City buildings range from about CD900 for two-bedroom units to more than CD1,000 for three bedrooms. Quebec, which tends to be more European than other Canadian provinces, has a steady rental market because residents prefer living in apartments. Turnover is 15 percent to 20 percent in Quebec compared to 35 percent in other parts of Canada and as high as 50 percent in Calgary. Buy Canadian Apartment REIT up to USD18.
RioCan REIT (REI.UN, RIOCF) posted a 16 percent rise in fourth quarter earnings on higher rental revenue. Net earnings for the quarter ended December 31 amounted to CD43.4 million, or 22 cents Canadian per unit, up from CD37.3 million, or 19 cents Canadian per unit, in the same period last year. RioCan owns and manages Canada’s largest portfolio of shopping centers, with ownership interests in a portfolio of 206 retail properties, including nine under development. Total rental revenue was CD151.2 million, compared with CD138.9 million a year ago, while funds from operations (FFO)–the most accurate measure of REIT health–was CD77.1 million, up from CD66.5 million.
For the year, the REIT posted profits of CD163.8 million or 83 cents Canadian per unit, up 23 percent from CD132.6 million or 68 cents Canadian per unit in 2005. Total rental revenue for the 12-month period was CD580.5 million, versus CD563.7 million in 2005, and FFO increased to CD286.6 million from CD257.4 million. At the end of 2006, RioCan’s occupancy rate was 97.7 percent. Buy RioCan REIT up to USD23.
Natural Resources Trusts
TimberWest Forest Corp (TWF.UN, TWTUF) reported that income slipped in the fourth quarter as weather and competitors on Canada’s Pacific Coast limited its log exports. The company also said it’s still looking for a buyer for its Elk Falls lumber mill on Vancouver Island, although an unnamed prospective purchaser is performing due diligence on the facility that sells largely to the Japanese market. TimberWest said it had net earnings of CD14.8 million in the quarter, down from CD30.9 million in the same quarter the year before. Sales in the quarter were CD110.6 million, down from CD132.8 million.
TimberWest stated that distributable cash in the quarter was CD27.5 million, or 35 cents Canadian per stapled unit, compared with CD29.7 million, or 38 cents Canadian cents per unit, in the same three-month period of 2005. TimberWest said while weather-related curtailments were creating log shortages and increasing prices, local sawmills in British Columbia were using provisions in Canadian trade rules to limit its ability to export those logs. Buy TimberWest Forest Corp up to USD14.