Poor Gord Nixon. The Royal Bank boss got the blame for whacking the income trust market in September, when he mused aloud at a conference that the bank might join the income trust parade. Within days, Finance Minister Ralph Goodale said (in so many words) that a trust clampdown was coming. He cited concerns over tax "leakage"--trusts are structured to avoid paying tax--and national productivity. Trusts pay out most of their operating cash flow to unitholders, leaving relatively little to reinvest in development and growth.
Linking Nixon to the trust turmoil was inaccurate in more ways than one. He actually said he'd be "surprised to see a bank convert to an income trust" and emphasized he was not "aggressively looking at major parts of our business in terms of conversion." Translation: The idea was a non-starter.
If anyone should take the blame for the wounding, and possible demise, of one of the hottest investments in recent decades, it is Hank Swartout. Swartout is the CEO of Calgary's Precision Drilling, one of the marvels of the West's oil and gas industry. He and his investors got rich by applying a lesson from the gold rush: Find the guy who's trying to find the gold and sell him the tools he needs--it's a surer bet.
Founded in 1951 and associated with Swartout since the mid-1980s, when the company he led, Cypress Drilling, acquired Precision and adopted the name, Precision is Canada's largest contract driller and oil field services company. It has a market value of about $6 billion and had operating profits last year of $424 million. With operations in more than 30 countries, it is also on the verge of joining the international big leagues.
Make that was on the verge. Precision is in full and rapid retreat from the world stage. It formally revealed on Sept. 7 that it would convert its Canadian operations in November into an income trust, whose tax-free status would allow it to trade at a higher-value multiple than a traditional company. But what about its vast foreign operations? In apparent preparation for conversion, they vanished in June, when Weatherford International of Houston paid about $2.3 billion (U.S.) for Precision's international contract drilling division and energy-services division, which housed its world-leading technology and research and development activities. Trusts typically do not contain non-Canadian operations, partly because it is difficult to repatriate foreign income to a tax-free entity.
Now it is Weatherford, not Precision, that is joining the big leagues in drilling and technology. Here's what Weatherford boss Bernard Duroc-Danner said about Precision when he bought it: "Frankly, we could not duplicate what they did, and we need it."
At that point, Goodale and his senior policy wonks cringed, though they made their concerns known only privately at the time. Here was one of Canada's few global champions, led by one of the industry's most respected entrepreneurs, shredding its growth playbook and unloading many in the team of senior executives who had helped build the company--for no other reason than to avoid paying tax. That much was known. Shortly after the Weatherford sale, Swartout said he had no choice but to convert "because the multiple of the trust is so overwhelming," even though he admitted the trust proliferation "is not the best thing for Canada."
The reversal was indeed stunning. In Precision's 2004 annual report, words such as "global," "world class," "leader," "leadership" and "research" were mentioned about 100 times. In the CEO's message, Swartout talked about the company's "bold global direction." That year, Precision spent $49 million on research and engineering, equivalent to 2% of its $2.3 billion in revenue. Precision had trademarks on some of its technology. One is the Revolution rotary steerable system, in which a well is drilled vertically to a certain depth, then kicks off at a 57-degree angle. This saves money because the drilling rig does not have to be moved to test various parts of a reserve for oil flow.
The truth is that Canada's most successful companies, and the ones that attract the best and the brightest professionals--Manulife, Bombardier, Scotiabank, Magna and Alcan, among them--have one thing in common: They're players on the international stage. Canada needs more of them. When ambitious companies like Precision suddenly call it quits to exploit a tax loophole, you know you've got a problem.
Maybe Hank Swartout did Canada a favour by drilling this message into Ralph Goodale's head.
© The Globe and Mail
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