Starving for yield
Prime Restaurants IPO: New 'casual dining' income trusts may cause indigestion
Ian Karleff
National Post
Friday, July 12, 2002
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Investors are begging for a decent return in a yield starved market -- or at the very least preservation of capital.
That goes a long way in explaining the popularity of income trusts, which have, like Nortel Networks before it imploded, found a place in most people's portfolios. Income trust yields, which range from 8% to 15%, are a far cry better than the 2% interest payment paid by the average fixed income product like GICs.
Investors gobbled up $3.9-billion of income trusts in the first half of the year, sparking a pace in initial public offerings not seen since the technology fuelled first-half of 2000.
"This is the only game in town. Clients want something in their pockets at the end of the day, like tax relief and income," said a broker at one of Canada's Big Six banks.
Trusts are so hot that they are trading more on yield than on their fundamentals. When oil and gas prices and commodities in general were sinking from May to December, 2001, energy-based royalty trusts, which should trade on the underlying commodity, remained virtually unchanged, says Roger Serin, a royalty trust analyst at Raymond James.
"We thought there was a disconnect, so we changed our view to negative," said Mr. Serin. "But people had nowhere else to put their money."
Investment bankers are only too happy to supply new product to satisfy the demand. Which brings us to the newest fad: restaurant-based income trusts.
There are at least six income trusts poised to come to market, and of those, "casual dining" is proving to be a big hit in the early stages of syndication.
Prime Restaurants, which owns the royalty rights to 128 Casey's, East Side Marios and Fionn MacCool's Pubs, is planning what is thought to be a $300-million IPO, while Boston Pizza is looking to raise about $77-million, following on the wildly successful $83-million offering of A&W Revenue Royalties Income Fund.
Mr. Serin is confident that old-style oil and gas trusts will stand the test of time, but he does question the longevity of some of the newer trusts coming to market.
"It's certainly possible that newer, non oil and gas trusts will blow up, as these are structured to meet a short-term market demand," he said.
Restaurants generally don't fit the typical criteria for income trusts: stable businesses, based on a non-discretionary service, with low capital expenditure costs, little competition, low debt, high free-cash flow and independent of economic cycles.
However, they do fit the criteria of being mature businesses with little potential for future growth, as they crowd into the parking lots of suburban malls and fight to feed cooking-reluctant shoppers with a spare $15 in their pockets.
And while Prime and Boston Pizza have both lost money in two of the past three years, investors in the short run don't really care because their royalty payment comes "off the top," which means that the payment is based on between 3% and 4% of total sales rather than pre-tax cash flow.
Trust watchers say the seasoned investor remembers 70% drops in the units of coal-related income trusts, such as West Shore Terminals and Luscar Coal, and Rogers Sugar, when natural gas prices soared and sugar prices dropped. So investment bankers are installing safeguards, or sweeteners, into the new generation of income trusts, such as "off the top" royalty payments.
"I think this is a structure that was the creation of the accountants, and when you have an interesting structure, it attracts, good, mediocre and indifferent. You have to do your homework," said Canaccord Capital Corp. senior vice-president Peter Chandler.
Try this for homework: Prime pays royalties of $9.3-million, $9.8-million and $10.2-million over the next three years based on a 3.25% royalty and sales growth of 5% as was the case in the past year. The net effect, taking into consideration average losses of $630,000 a year excluding a paper gain on reduction of debt, is a 3-year deficit of $31-million. How long until the royalty is slashed or the business goes under?
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