Canadian Trusts Come Up Roses

Forbes.com: Gordon Pape, 04.21.07

Investors who had a bucket of mud poured over them when Canadian Finance Minister Jim Flaherty announced a tax on income trusts on Halloween may come out of it all smelling like roses.

Canadaís booming trust market deflated like a punctured balloon after the news, losing an estimated 30 billion Canadian dollars in market cap in the days immediately following the stunning announcement. Panicky investors on both sides of the border jumped ship and sold at prices that in some cases were down 25% to 40% from their Oct. 31 close.

Americans stand to be particularly hard-hit by the tax, which does not kick in until 2011. Not only will they have to pay the usual 15% Canadian withholding tax but trust distributions will be cut by up to 31.5% at the source (the exact amount may vary depending on a trust's available tax pools).

The trust tax has sparked angry reaction on both sides of the border. In Canada, lobby groups have been formed to pressure the Conservative government of Stephen Harper to withdraw or at least soften the policy. So far, their efforts have been fruitless. US opposition has been less formal, although at the February World Money Show in Orlando, Fla., representatives of Canadian energy trusts circulated a protest letter which they urged Americans to send to the Canadian Embassy in Washington.

During seminars I gave at the show and in private talks with members of the buildingwealth.valueforum.com investment Web site, with which my newsletters are associated, I heard comments like "Canadaian Prime Minster Stephen Harper is no better than Hugo Chavez" and "Iíll never invest in Canada again." Strong words indeed.

Well, guess what? Itís suddenly looking like investors who held on to their Canadian trust shares may come out of this mess much better off than anyone expected. Private equity groups and companies with huge cash reserves are descending on the lame duck trust sector and snapping up assets at prices that in some cases exceed the highest trading levels ever achieved as public entities.

Just recently, we have had a classic case of a small fish being swallowed by a bigger fish, which in turn was swallowed by a giant fish. On April 16, UE Waterheater Income Fund announced it had reached an agreement to buy the much smaller VOXOM Income Fund for C$13.25 a share, a 29% premium over the previous closing price. About two hours later came word that UE Waterheater itself was being taken out by Alinda Capital Partners LLC for C$23 a share, a 46% premium. Alinda is a private investment firm based in New York.

Also this week came the news that Macquarie Power will acquire rival Clean Power Income Fund for C$6.17 a share in a C$226 million deal that was reached following a bidding war with Algonquin Power that drove up Clean Powerís share price from a November low of C$5.01.

That was just the latest in what is turning into a race to snap up the most attractive of the Canadian trusts. Earlier this month, Gateway Casinos Income Fund announced it has accepted a takeover offer of C$25.26 per unit from Australiaís New World Gaming Partners Ltd., a joint venture owned by Publishing and Broadcasting Limited and Macquarie Bank Limited. The offer was 25.7% above the last closing price.

A day before the Gateway news came out, KCP Income Fund announced it had entered into an agreement with Caxton-Iseman Capital, a New York-based private equity firm, to be taken over at a price of C$10 a share in a deal worth C$804 million. The C$10 bid represents a 25% premium to the March 30 closing price and a 45% premium over the low of C$6.90 hit after the Oct. 31 tax announcement.

Thereís more, much more! tOn March 28, Great Lakes Carbon Income Fund announced it had entered into a definitive agreement with Oxbow Carbon & Minerals Holdings to be taken over at a price of C$14 per unit in a cash deal worth about C$527 million. Oxbow is a U.S. company based in West Palm Beach, Fla.

In this case, the share price didnít spike up because a takeover battle between Oxbow and a company based in India had been going on for some time. But the bid price represented an all-time high for the units and a premium of about 40% over its November low.

Previously announced trust takeovers include Lakeport Brewing Income Fund by Labatt at a premium of 36%, Entertainment One Income Fund by U.K.-based Earl Street Capital Ltd. at a 33% premium and Amtelecom Income Fund by Maritime-based Bragg Communications for a 26.7% premium.

Now analysts are speculating that even the biggest trusts are fair game. Toronto-based Dundee Securities issued a report on April 16 suggesting that Yellow Pages Income Fund, with a market cap of C$7.5 billion, could be an attractive target for a private equity leveraged buyout at a price ranging from C$15.25 to C$17.28 a share. Yellow Pages was trading on Thursday at C$14.28.

The corporate raiders are clearly on the prowl, and Canadaís embattled trust sector has become fair game. There are going to be many more takeovers in the months to come, and if the premiums we are now seeing are any indication, patient investors can expect to be rewarded. And while youíre waiting, the monthly distributions will keep flowing in. Perhaps this will all work out much better than anyone expected back on Oct. 31 when Mr. Flaherty pulled his Halloween trick.

Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. His comments appear regularly on the ValueForum.com Web site. For details on a special one-month introductory offer, visit buildingwealth.valueforum.com.

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