The other day I had a pretty good idea. It is similar to the thesis for investing in spin-offs and re-organization securities.
The government of Canada recently implemented a tax law that removes the preferential tax treatment of income trusts, which were previously untaxed at the corporate level. Without the preferential tax treatment, financially, these "businesses" are better off under the corporate structure. And as of 2011 they must all be converted to the corporate structure.
These trusts were typically held because of their high annual cash distributions yields. When these trusts convert to the corporate structure they will either cut the dividend drastically in order to keep cash in the business or change to growth oriented model in which the dividend is cut completely. What happens here is that all the pension funds, insurance companies and dividend mutual funds that had owned units in these trusts are forced to dump the units because they must hold income paying securities. The forced selling causes downwards price pressure and the price becomes disconnected from the underlying value of the company. This is an attractive purchasing opportunity; eventually the market will weigh the proper value of the company and will be reflected in the per unit price.
SG
Saturday, June 6, 2009
Subscribe to:
Post Comments (Atom)
Interesting. A lot of us who have been in the markets for a number of years invested in income trusts because they were excellent investments…until the government intervened and announced the mandatory tax in 2011.
ReplyDeleteI had always planned to sell my income trusts before 2011, and I have sold a few, but still own two. Are you suggesting that possibly I should hold these until after the deterioration in 2011, and wait for the recovery?
They will still most likely be valued at less then the income trust due to the taxation (lower cash flows). Although some of them may convert to growth models in which excess cash is reinvested in the company. However, it would be many years before the cash they generate equals the equivalent without the corporate taxation. For example, an income trust distributes $100 per share before conversion. After conversion, assuming a 30% tax rate they now have (1-.3)(100) = $70. Assuming all else is constant, they would have to grow revenues by 1/.7 -1 = 43% in order to have equivalent cash distribution to before conversion.
ReplyDeleteMy intention with this article was to suggest purchasing the shares of these newly converted corporations when they become undervalued due to forced selling by pension, insurance and mutual funds.