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Posts Tagged ‘Hunter’

Over the past five years, the income trust model has played the role of the hunter, searching out mature businesses that generate a steady income stream to flow through the trust and distribute to the trust’s unitholders. However, on October 31, 2006, the Canadian federal government announced that it would be introducing a new taxation scheme, effective 2011, for most publicly traded income trusts. The result of this new scheme is that the traditional tax advantages enjoyed by these income trusts – namely, little or no tax payable by the trusts on distributions to unitholders – were virtually eliminated. Signaling the serious diminution of tax savings for trust investors, this announcement wrought havoc on the TSX in the days after Minister of Finance, Jim Flaherty, revealed the new regime. As unit trading prices for many of these income trusts started to fall, more and more investors began looking for alternative investments and, as many predicted, the creation of new income trusts declined significantly. In fact, it was shortly after the proposed changes were revealed that BCE Inc. announced that it would no longer be proceeding with its earlier stated plan to convert to an income trust.

So, what of the fate of existing income trusts? The devalued unit prices of these once flourishing income trusts have left them vulnerable to acquisition by businesses, private equity investors (typically foreign) and other income trusts on the hunt. As such, the recent trend has been the acquisition, rather than the creation, of income trusts in Canada. Many of the considerations that apply in the context of corporate M&A transactions also apply to similar transactions involving income trusts. However, there are a number of issues that are unique to the acquisition of an income trust, as distinct from the acquisition of a corporation.

The most significant issue is that unlike a corporation, an income trust is not subject to corporate statutes, such as the Ontario Business Corporations Act or the Canada Business Corporations Act. An income trust is instead governed by a Declaration of Trust, which is to the trust as the Articles of Incorporation, By-laws, and governing corporate statute are to a corporation. As a result of this, the statutory mechanisms of Amalgamation and Arrangement are not available when acquiring an income trust (although similar mechanisms may be included in the trust’s Declaration). Therefore, the scope of potential transaction structures may be narrower and the acquisition of an income trust will likely have to proceed by way of acquisition of the outstanding trust units, on either a friendly or hostile basis.

Furthermore, while Declarations of Trust are often based on provisions of corporate statutes, each one is unique and presents different issues for a potential acquiror. For example, when acquiring a trust (as with a corporation), it is unlikely that all of the outstanding units will be tendered to the acquiror’s bid. However, the continuing existence of an outstanding minority interest is generally undesirable. As a result, it will be necessary for the acquiror to undertake a “second-step transaction” to acquire the remaining units not tendered to the acquiror’s bid. Corporate statutes provide a clear framework for compulsory acquisition of minority interests in certain circumstances. On the other hand, the Declaration of Trust may not provide any similar mechanism, or the conditions for engaging the mechanism may be more onerous. In those circumstances, the acquiror may have to alter the terms of its offer, or effect an amendment to the Declaration of Trust (which generally requires the approval of unitholders). This is just one example of how the specific provisions of a Declaration of Trust can affect the mechanics of an M&A transaction involving an income trust.

The ownership structure of public income trusts, or “funds” as they are sometimes referred to, can also create additional challenges. Income trusts are created by a public offering of units, the proceeds of which are often used to acquire existing businesses. The vendors of these business(es) may retain an interest, typically in the form of securities, in the business. These “retained interests” can complicate the acquisition of an income trust as the securities will often confer voting and/or conversion rights that may allow the retained interest holder to influence the terms of an acquisition. As a result, it will often be necessary for an acquiror to make an offer to the trust’s unit holders, as well as any retained interest holder(s).

Interestingly, while corporate statutes do not apply to trusts, the same is not necessarily true of provincial securities laws. In public income trust takeovers, there is no relief from the often onerous provisions of securities legislation, as these income trusts are considered “reporting issuers” under securities laws. As a result, the same stringent rules relating to “going-private transactions” that protect corporate minority security holders will also apply in the income trust context unless the trust can bring itself within one of the exceptions available for other reporting issuers, such as public corporations.

Thus, we are left with a situation where the overwhelming effect is that income trust transactions are subject to the burden, but do not gain the full benefit, of various statutory mechanisms. In light of the increased income trust M&A activity since October 2006, there clearly seems to be a legislative disconnect with the practical result of the federal government’s decision to change the taxation structure of income trusts.

Nevertheless, these additional challenges associated with acquiring income trusts do not appear to have inhibited the level of M&A activity involving income trusts. A number of corporations have made bids for income trusts, such as New World Gaming Partners Ltd.’s bid for Gateway Casinos Income Fund and Labatt Brewing Company Limited’s (“Labatt”) bid for Lakeport Brewing Income Fund (which resulted in the latter’s acquisition by Labatt). But the income trusts’ predators do not end there. Stronger income trusts have also begun to cannibalize weaker trusts, as in the recent hostile bid by Liquor Stores Income Fund for the outstanding units of struggling Liquor Barn Income Fund. Private equity investors have also caught the scent of devalued unit prices, as in the recent bid by Alinda Capital Partners LLC for UE Waterheater Income Fund (which had itself just reached a friendly agreement to acquire Voxcom Income Fund).

Since the days following the federal government’s initial announcement, there has been some improvement in the unit trading prices of many of these publicly owned income trusts. Nevertheless, the new role of income trusts has clearly become that of the hunted, rather than the hunter. However, this may not be bad news for individual investors who may stand to gain from the takeover of their trust. As with some of the instances cited above, a trust’s unitholders will often be able to sell their units at a premium to the acquiror. This is at least one saving grace to those whose position in the economic food chain was so abruptly commandeered.