Investment journalist Gordon Pape today writes “Frankly, I don't see how Canada's national interest is served by such deals (purchase of Harvest Energy Trust state owned Korean National Oil Company) but the Finance Minister set this train of events in motion with his 2006 announcement and now he and the rest of us must live with the consequences. Don't be surprised if more energy trusts end up in foreign hands this year as the tax deadline approaches.”
Well that’s quite the defeatist attitude to take, especially given that the glass is 75% full with 75% of the trusts still out there and in Canadians control, and given that Flaherty’s alleged “tax leakage” can been totally solved via the “brilliant” Marshall Savings Plan. Or are we all masochists? Why should any Canadians allow Flaherty’s train wreck of a policy to continue, especially someone like Micahel Ignatieff who has been empowered by Canadians to STOP this kind of utter nonsense,. Come on Iggy....DO SOMETHING, and stop appearing to Canadians that you are “just visiting”, while Canada gets raped by foreigners under the policies of the moron Jim Flaherty.
Train of events? Also see the Hill Times piece by Professor Stanbury entitled Leadership? Here’s Ten Reasons Why the Tax on Income Trusts Was a Public Policy “Train Wreck
INCOME TRUSTS: LAST CALL
T-Day is less than one year away. Beginning in the 2011 tax year, the government will begin taxing income trusts -- businesses structured as trusts to avoid corporate tax. But when the tax does come into effect, there will be very few trusts left.
That was the objective of Finance Minister Jim Flaherty from the start. When he made his infamous announcement on Halloween 2006, it wasn't with the idea that the government would reap windfall profits from the trust tax. He really wanted to stop the trusts before they devoured the entire Canadian economy. The longer-term goal was to make conditions so onerous for existing trusts that they would simply disappear. He has succeeded on both counts, much to the dismay of hundreds of thousands of Canadians who viewed the trusts as a godsend in a climate of low interest rates. With bonds and GICs paying next to nothing, the trusts were one of the few sources offering decent cash flow for retirees. I still hear from people who swear they will never forgive Flaherty for his action, which, they never fail to remind me, was completely contrary to a promise contained in the Conservative election platform.
A few diehards are still fighting a rearguard action in the hope that Flaherty will miraculously see the light at the last minute. It's not going to happen. The trust sector is in its death throes. The next few months will be chaotic, replete with takeovers, mergers, corporate conversions and even some bankruptcies. There may be a few trusts left at the start of 2011, but they won't stay around for long. This means a lot of uncertainty for trust investors in the coming months. It also means some great profit opportunities for those astute and swift enough to seize them. These will come in two forms.
The FIRST WAY is through takeovers. We have already seen many trusts taken out at premium prices. The first wave came in 2007, after the implications of the new tax had sunk in. Then there was a long pause as the credit crunch dried up financing sources. But, in late 2009, the action started again.
The biggest deal in the fall of 2009 came as something of a shock. Harvest Energy Trust, never regarded as one of the strongest of the energy trusts, was picked off by Korea National Oil Corporation for $1.8 billion (plus assumption of $2.3 billion in debt), which represented a 47 per cent premium over Harvest's 30-day trading average. What made this takeover surprising is the fact Korea National Oil is owned by the South Korean government, suggesting that Ottawa is not going to block state-owned companies taking a greater stake in our energy sector (regulatory and court approval was pending at publication).
Frankly, I don't see how Canada's national interest is served by such deals, but the Finance Minister set this train of events in motion with his 2006 announcement and now he and the rest of us must live with the consequences. Don't be surprised if more energy trusts end up in foreign hands this year as the tax deadline approaches.
At about the same time as the Harvest deal was being consummated, Livingston International Income Fund, which provides customs, transportation and integrated logistics services, became the target of a takeover battle. Initially, the trust agreed to be acquired by a consortium of the Canada Pension Plan Investment Board and Sterling Partners for $8 a unit, which was a 29 per cent premium over the volume weighted average price of the units over the 30 trading days prior to the announcement.
That set a bidding war into motion. Mullen Group, a competing business with many synergies to Livingston, announced a $300 million all-stock bid, which would have been worth about $8.77 a share at the time of the offer. That was 9.6 per cent better than the CPP/Sterling bid and 144 per cent above Livingston's low of $3.60 in March 2009. At the time of writing, no final decision had been made, but Livingston's shares were trading higher than the Mullen bid, suggesting the markets believed the fight wasn't over.
What is clear from these takeovers is that it is almost impossible to predict where lightning will strike next. Even weak trusts have the potential to produce big gains in the coming months provided they control attractive assets. Here's what to look for.
1. Strong cash flow. Potential acquirers will pay a premium price for trusts that generate steady, predictable income.
2. Valuable assets. Rich oil and gas reserves will pay off over time. The vultures are hovering,looking for those that can be acquired at bargain prices.
3.Clean balance sheets. No one wants to take on a lot of debt right now. If a trust is heavily leveraged, it will be much less attractive as a takeover target and any offer will be framed accordingly.
4.Committed management. A wellrun trust with a respected management team that is willing to carry on under new ownership will be viewed as a prize target.
The second way to profit from the trust turmoil is to invest in what I call "survivor trusts" -- those that will convert to corporate status while maintaining their distributions at or near previous levels. As this happens, a new type of security is created: the high-yield stock. Historically, stocks with high dividend yields have been viewed with suspicion because investors see this as a sign the company is in trouble and that a dividend cut is likely. However, the current situation is unprecedented and offers some great opportunities.
Crescent Point Energy is a classic example of this phenomenon. After it converted to a corporation in July 2009, it continued to pay a monthly dividend of $0.23 a share ($2.76 a year). At the time, the shares were trading in the $30 range for a yield of approximately nine per cent. Smart investors quickly realized this was a great deal and snapped up the stock. At the time of writing, it was trading around $38 and the yield was down to a more realistic 7.3 per cent.
We saw a similar, albeit less dramatic, situation with food distributor Colabor Group, which converted from a trust to a corporation in August 2009. In December 2008, the trust units of Colabor traded as low as $5.90 to yield 18.2 per cent. The price gradually rose through 2009 and, in the late fall, after the company had confirmed it would maintain its $1.08 annualized payout as a corporation, the shares were trading in the $10 to $10.50 range.
I believe we will see the same pattern with other survivor trusts. As they convert to high-yield stocks, the share price will rise and the yields will drop to the six per cent to eight per cent range, depending on the strength of the company. So the concept of the high-yield stock is likely to be transitory. Bargains don't last long in the stock markets.
Over the past year, we have identified several survivor trusts in my Income Investor newsletter, and all have subsequently risen in price. I believe there are still more out there. Here are the guidelines we use.
1. The trust must be in a strong financial position. Those that held up well during the recession are especially attractive because it indicates the underlying business is solid.
2. Management and the directors must have demonstrated a commitment to the interests of the shareholders and have made or are making decisions aimed at minimizing the negative impact of the trust tax.
3. The trust has taken a conservative position in establishing its distribution policy, keeping payout ratios at a responsible level.
4. A clear plan of action to deal with the tax has been established and announced, providing investors with welcome transparency in a difficult period.
I expect events in the trust sector to happen quickly in the coming months. In fact, by the time you read this, several new deals will probably have happened. If you want to take advantage of the situation and perhaps recoup some or all of the losses you suffered when the Finance Minister announced he was shutting down the sector, talk to your investment adviser about current opportunities. There's money to be made, but the window is closing fast. Don't miss out.
Gordon Pape's latest book, The Ultimate TFSA Guide: how to build a Tax-Free fortune, is published by Penguin Group Canada. illustration, David Sipress/Condé Nast Publications
Thursday, March 11, 2010
Gordon Pape questions whether trust policy in Canada’s national interest. What’s Ignatieff’s position?
Posted by Fillibluster at 8:43 AM