Energy Trusts -- Potential Hostile Takeover
Full Story: bloomberg.com
Bloomberg reports: Canadian Finance Minister Jim Flaherty's proposed tax on income trusts to stem declines in government revenue may spark a rush of takeovers in the energy industry by foreign buyers seeking cheap assets.
The 12 percent plunge yesterday in the Standard & Poor'/TSX Capped Income Trust Index, which wiped out C$24 billion ($21 billion) in market value, has made trusts such as Canadian Oil Sands Trusts more attractive, investors and executives said.
``Canadian Oil Sands is in play. Who would not want to buy it if it's down 15 to 20 percent,'' said John Priestman, who helps manage about $5.3 billion in income trusts at Guardian Capital LP in Toronto.
A surge in foreign takeovers of income trusts would mean the government's attempt to stem a decline in tax revenue by taxing trusts may have the opposite affect, said Lee Goldman, a money manager at First Asset Funds Inc. in Toronto.
``They get too cheap and they get taken out, so you have a whole stream of companies moving south of the border, and you lose the tax from that company anyway,'' said Goldman, who helps manage $971 million at First Asset. ``It could come back to bite the government.''
Flaherty blindsided investors and executives after markets closed Oct. 31, announcing that trusts would be taxed for the first time. New trusts would be taxed next year, while existing trusts would be exempt until 2011. He said his government needed to clamp down on trusts because too many companies were converting, primarily to save taxes. Trusts avoid corporate taxes by paying out most of their cash flow to investors in monthly dividends.
Sell Off
Trusts plunged yesterday in response to the announcement. Canadian Oil Sands, the largest income trust in Canada, declined 9 percent. Focus Energy Trust plunged 17 percent and Penn West Energy Trust was down 14 percent, the biggest decline in more than a decade.
``Where you've seen a Canadianization of the energy industry, it will go the other way, there will be a lot of purchases,'' William Andrew, 54, chief executive officer of Penn West said in a telephone interview from Calgary.
The decline in Canadian energy income trusts will make them more attractive to foreign companies interested in acquiring natural gas and crude oil assets, BMO Capital Markets analyst Gordon Tait said. The new tax structure also removes a disadvantage foreigners faced when buying a Canadian trust. Under the current rules, a trust would lose its tax exemption if it were controlled by non-Canadians, meaning buyers would be paying for a benefit they couldn't use.
Takeovers
``As some of these assets get sold off and some of these good companies get sold down, you could see more foreign takeovers, in which case you could see a lot of income stripping coming out of Canada,'' Andrew said.
Foreign producers are trying to take advantage of a surge in production from the oil sands and other production areas in Alberta. Peters & Co., a Calgary-based brokerage specializing in energy, has calculated total acquisitions of producing assets in western Canada at C$22.7 billion in 2006, with 60 percent of the buying in the trust sector, managing director of research Andrew Boland said in an interview. That's about double the pace for all last year, he said.
``Let us be clear on one thing: to many the next few weeks or months may provide an opportunity, perhaps of a lifetime, to acquire great Canadian businesses at potential fire-sale prices,'' Dirk Lever, analyst at RBC Capital Markets, said in a report to clients. ``Canadian oil and gas trusts, some with incredible assets, could find themselves very, very, vulnerable.''
Vulnerable
The most ``vulnerable'' energy trusts include Penn West, ARC Energy, and Canadian Oil Sands, Lever said in the report. Penn West, ARC Energy and Canadian Oil Sands all have long-term projects and have no controlling shareholders.
Units of Penn West declined to C$36.11, giving the trust a market value of C$8.5 billion. ARC Energy fell 16 percent to end trading at C$4.7 billion and Canadian Oil Sands slumped to a value of C$12.8 billion.
Penn West and Canadian Oil Sands both would provide access to Alberta's oil sands. As much as C$125 billion will be spent by 2015 to boost output from tar-like deposits in Alberta, the largest source of reserves outside of the Middle East, Canada's National Energy Board said in a June report.
``All of the trusts will be gone and those assets will be distributed among other companies. The capital is not in Canada,'' said Andrew, whose trust has output of about 93,000 barrels of oil equivalent a day.
Foreign-controlled companies are responsible for about half of Canada's daily oil and gas output, according to data compiled by the Canadian Association of Petroleum Producers. Trusts control about 14 percent of daily output.
``At the end of the day, the people who are smiling now, people in provincial treasuries and the federal government probably won't be in four years,'' Andrew said. ``They've done this all for a perceived C$500 million tax gain.''
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