Do fries go with that trust?
Wednesday, January 16, 2002
Andrew Allentuck
Winnipeg (GlobeinvestorGOLD) -- A&W Food Services of Canada Inc. is planning a $100-million sale next month, but this time it’s investment units, not Mama Burgers.
The company, which operates nearly 600 fast food stores, said it will go public next month via an income trust. For investors, the creation of a royalty trust structure on top of the underlying burger business raises the question: Why not sell stock?
Jeff Mooney, A&W’s chairman and CEO, said the offering will help eliminate debt “while allowing management to control the direction of the business.” The offering is structured and timed to appeal to investors who want income rather than asset growth. A&W clearly hopes investors will bite.
Royalty trusts are common in the oil and gas business and in real estate development. They are often used when managers of the underlying assets sense that growth has slowed so much that the asset should be turned into a cash cow that no longer plows earnings back into the business. Or management uses the trust scheme as a way to get out of a stock that perhaps has no market or that would have to be sold at a very low price. By creating the trust, management creates an intermediate buyer and controls the pricing of the underlying assets.
“Ultimately trusts are created to increase the market value of the investment,” said Richard Howson, executive vice-president of Howson Tattersall Investment Counsel in Toronto. “As a corporation, the company must pay taxes on income. As an income trust, the tax liability is passed through to the unit holders.”
“Trusts defer taxes by returning capital to unitholders,” Mr. Howson explained. “But there is a hit at time of disposal when the adjusted cost base of the units has decreased by the amount of capital returned to holders then there is a larger capital gains liability than would have existed had the capital not been returned.”
Income trusts appeal to investors who may not want shares in the same company, Mr. Howson said. “When it was a corporation, the underlying firm was valued on earnings and growth. In the case of many entities that become income trusts, growth prospects are not high. As trusts, they pay out the bulk of cash flow and they are priced in a fixed income market.”
Valuations change too when a business moves from a public company to an income trust.
“Average oil and gas properties sell for 4 times cash flow, a 25 per cent return,” Mr. Howson said. “As royalty trust, they tend to go for much higher valuations.”
Income trusts have moved beyond resources and real estate. There are already royalty trusts for food -- Rogers Sugar would qualify for that. In the near future, royalty trusts based on companies with businesses as diverse as customs brokering and public cold storage are expected to come to market. Is the market ready for a royalty trust based on fast food?
It may depend on how this burger deal is stacked. The A&W offering will be structured to pay on sales rather than earnings, said Garth Jestley, president of the Middlefield Group, a Toronto-based investment management company with $1.6-billion under management.
“I would think that per capita consumption of hamburger is a mature market. In this case, they are creating a distribution stream out of payments that come off the top line. The offer is opportunistic because they think that they can get a good price. After all, the market is currently strong for income products and less strong for equity offerings.”
Yet fund managers are taking a careful view of the A&W offering.
“This is not really fixed income, even if the units are high yield,” Mr. Howson said. “They should be valued as equities -- not as odd bonds.”
The units will be priced to sell, but adding a coupon for fries might help |
