Friday, September 5, 2008

BCE's junk bond binging versus H&R's stapled diet

H&R's stapled diet

Barry Critchley, Financial Post Published: Friday, September 05, 2008

Unitholders of H&R Real Estate Investment Trust gather in two weeks to vote on an internal reorganization that will create another company that has a stapled unit security. Indeed, if BCE Inc.'s directors had responded to a proposal from Catalyst Asset Management last year -- and agreed -- BCE's shareholders would have been called to a similar meeting.

H&R's meeting comes four months after it said it was contemplating a possible internal reorganization "for the purpose of creating a structure that would be more efficient for the REIT from both an operational and tax perspective." The plan was conditional on a number of matters, including the support of the trustees and the unitholders and on receiving an "advance income tax ruling from the Canada Revenue Agency confirming certain Canadian federal income tax consequences." That has since been received, so it's now up to the unitholders to pass judgment.

The plan is complex. (The circular runs to 224 pages, complete with charts and lots of text.) "Although the Reorganization is intended to be economically neutral, the steps of the Reorganization are highly technical," said H&R, noting that the reorganization was motivated by the REIT's capital requirements, expectations of its unitholders, U. S. tax legislation, Canadian tax implications and the ongoing costs with the stapled unit structure.

Here's the Coles Notes version: - A unitholder will receive a unit of a sister trust, H&RFinance Trust, whose sole activity will be to hold debt issued by a wholly owned U. S. subsidiary of the REIT through which the REIT holds its U. S. interests. A unitholder's investments will be held through the old REIT unit and through the new trust, H&R Finance Trust. Each outstanding REIT unit will trade together with a unit of H&R Finance Trust as a stapled unit. "The Finance Trust Units and the REIT Units should be treated as two separate instruments traded together," notes the circular. - Unitholders will receive distributions from both the REIT and H&R Finance Trust. Indeed, H&R says "the combined distributions would exceed the distributions that would have been payable by the REIT in future years in the absence of implementing the Reorganization." - An asset transfer whereby a REIT subsidiary, which holds an interest in a Calgary office tower, will transfer its assets to the REIT.


TimberWest Forest Corp. is another Canadian company that has a stapled unit. Its stapled units consist of one common share, 100 preferred shares and $8.98 of subordinate notes. Taiga Forest Products is another. In 2005, it converted from a corporation to an in-come fund-like structure using stapled units. Each share was exchanged for four stapled units, with each stapled unit consisting of a common share plus a 14% subordinated note.


In Catalyst's proposal for BCE, a special-purpose company would offer a stapled security for each outstanding BCE share. The stapled security would consist of a share and a debt security, with the initial payout (interest and dividends) of $2.55 a year -- versus $1.46 paid on the common shares.

"A stapled security is a vastly more elegant way to do a public leverage buyout and not ruin the credit rating of the company," said Brent Fullard, Catalyst CEO. "It would have worked well in BCE's case because it represented a value-maximizing, tax-efficient way to distribute the earnings of BCE to the existing shareholders rather than the new private equity and the owners of $44-billion of debt."

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