A Category 5 takeover hurricane is sweeping through corporate Canada. When it dies down in six months, or a year, or three, there will be far fewer head offices in this country. But help is on its way, courtesy of Finance Minister Ralph Goodale's changes to the taxation of dividends shortly before the demise of Paul Martin's minority government. No, the feds didn't bring back the Trudeau-era Foreign Investment Review Agency. Instead, they made the Canadian market slightly more resistant to takeovers by leaving the income trust market and its high valuations essentially unscathed. By the late autumn, some $30 billion worth of Canadian companies was in play. Jerry Zucker, the secretive South Carolina investor, had launched a takeover bid for ailing Hudson's Bay Co. Corporate raider Carl Icahn had accumulated a 9.3% stake in Fairmont Hotels & Resorts, which has holdings that include Toronto's Royal York and the Banff Springs Hotel. Constellation Brands of New York had taken a run at Vincor, Canada's premier winemaker.
We're just getting started here. Essentially, the entire Canadian mining industry had come up for grabs by Halloween. Barrick Gold had launched a $9.2-billion (U.S.) hostile offer for Vancouver's Placer Dome, which may be challenged by Denver's Newmont Mining. Inco had delivered a friendly $12.5-billion takeover offer to Falconbridge. But there were rumours of an unsolicited bid from Xstrata, the aggressive Anglo-Swiss mining group that already owned 20% of Falconbridge.
Takeover waves seem to hit every five to 10 years. This looks like the biggest one ever, thanks to low interest rates, high commodity prices, strong free cash flows, epic amounts of private equity, high-multiple stocks that can be used as takeover currencies, and bosses who are under pressure to show growth instead of sitting on mountains of (taxable) profits.
What does all this have to do with income trusts? None of the companies in play is a trust or intends to become one (that we know of). But look at the businesses that haven't been takeover targets, even though they look attractive: They include YellowPages, the Brick (the furniture retailer), Legacy (the luxury hotel owner), Fording Canadian Coal, Superior Plus (the propane distributor) and Gaz Metro (the natural gas distributor).
Those companies have already been converted to income trusts, part of a trust contingent on the TSX worth about $175 billion. They are all essentially takeover-proof because trusts trade at higher multiples than regular companies do. That's because trusts pay virtually no tax and distribute most of their cash flows to investors (who are taxed on the income). Trusts can buy other trusts, but hostile takeovers are almost unheard of because slapping one premium on top of another makes zero sense.
There's lots to dislike about trusts. They exist to pay out profits, not reinvest them in future growth. You rarely see the words "entrepreneurial" and "income trust" in the same sentence. Almost all are locked into the small Canadian market. They also created "tax leakage" for Ottawa, though the amount is uncertain.
In September, Goodale signalled his intention to clamp down on the trust market. Taxing them was an option. Trust values plummeted and trust conversions and initial public offerings came to a standstill. Two months later, likely spooked by a potential backlash among trust-loving voters, His Ralphness backed off. Trusts were left unscathed. Instead, he boosted the dividend tax credit, putting corporate dividend payments and trust distributions on a roughly equal tax footing.
The market went into party mode. The S&P/TSX Composite Index hit a five-year high. Income trust values rose, and trust conversions and IPOs came back from the dead. Dividend-paying companies--including banks, telecoms, insurers and utilities--went up even more. Companies that trade at higher values aren't takeover-proof, as giddily high offers for Dofasco and others proved. But they are less vulnerable to takeovers because they are more expensive. And thanks to Goodale, companies that had shied away from turning into trusts will reconsider that option.
If Goodale had whacked the trusts, companies would have found other ways to boost shareholder value. Slapping a For Sale sign on the front lawn would have been one of them.
A disturbing feature of Canadian takeover waves is foreign buying, and many companies would have been frog-marched to the border. As the takeover pace gains momentum, Canada is still at risk of turning into a branch-plant economy. But the Liberals' pre-election reversal--whether the result of cowardice or calculation--will probably slow the process somewhat.
© The Globe and Mail
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