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It has all the makings of a gold rush. There are the underground riches. The surge of prospectors looking to get in. And, of course, there can be promises of a quick buck.
New energy trusts trade with assets in Texas
Photo: Pat Sullivan/Associated Press
This time, however, the gold is oil, and the gold fields are anywhere but Canada—usually in the United States, but with the promise that the whole world is ripe for prospecting.
The rush is for so-called “foreign asset income trusts,” following a novel model that has seen new energy trusts trade on Canadian markets with a portfolio of assets outside the country (in places such as Texas and Oklahoma, but also potentially in South America or Europe) and with assets extending beyond oil.
Using non-Canadian assets allows this new trust model to circumvent rules that took effect in 2006 that increased the tax burden on trusts with domestic holdings.
The possibility of creating a compelling new corporate model, and responding to a desperate market hunger for yield, has sparked numerous groups to join the rush.
Rafi Tahmazian, a senior portfolio manager at Canoe Financial LLP in Calgary, said that in recent months he has been approached by five groups asking him to get on board. They have asked him to be an investor, a director, even “run something,” he said. “It’s crazy.”
In Calgary, a city traditionally thick with promoters talking up the next great oil or gas play, there is nothing surprising about promises of new ideas that could bring big gains.
But Tahmazian said he has been startled by the expectations being proffered by backers of the new trust model.
Trusts have traditionally been havens for investors–places to park money and reap yield. The trust space has been occupied by relatively mature companies that promise stability, rather than players searching for a gusher of a new well, for example, that could double or triple a share price.
“All the deals I’ve been shown, guys are dangling, ‘Do you want to make a fast four-bagger or five-bagger?’” Tahmazian said. In other words: Invest now, and you could see a 400-per-cent to 500-per-cent return by the time of an initial public offering.
“My attitude is, ‘Look, if you want this system to run smoothly, the front-end promotion can’t be that dramatic,’” he said. “Remember, on the other side of it, who is buying this? Grandmas and grandpas.”
There is an attractive business model to the new trusts; there are tax advantages to these structures, but the attractiveness of the proposition runs deeper.
In the United States, so-called “master limited partnerships” are effectively the equivalent of Canadian income trusts. But MLPs have traditionally been used differently for energy assets, spending less time exploring and drilling for new production than their Canadian cousins.
Canadian companies often place more value on undeveloped oil and gas resources, which can allow them to bid slightly higher prices for U.S. assets and lets them produce more out of those they acquire. This provides a lift to both the U.S. sellers and the Canadian investors who might one day see more production.
And it’s not only Canadians looking to do this. Increasingly, foreign management teams are looking to raise money in Canadian markets to run foreign assets, using this model as a new financing vehicle.
“There’s a lot of interest in it,” said Murray Lee, who leads PricewaterhouseCoopers’ cross-border tax practice in Calgary and has been one of the pioneers of the new trust model.
He acknowledged, however, that some of the interest comes from “less sophisticated” groups, and said any pledge of a four or five times return “would make me nervous, I’ll tell you.”
Starting a new venture, especially a foreign asset income trust, is risky. Building a new company is arduous, time-consuming and expensive.
“These structures are not cheap to implement because of all the cross-border aspects. So [early investors] put up their seed money and they take 100-per-cent risk that the IPO might fall flat,” Lee said. And few question that high risk demands high reward.
One company that sought major returns, won little favour with markets. Sources said the Calgary company met less than a quarter of its sought-for IPO value when it tried late last year.
And the sheer complexity of assembling one of these deals should serve to protect investors, said Richard Clark, chief executive officer of Eagle Energy Trust.
“Whenever there’s an innovation in the business model, you always see a bunch of people circling around it,” he said. “But it takes a pretty sophisticated group to pull that off, and I think the checks and balances in the system will solve for virtually all of that stuff.”
For example, he said, the size of these deals – and their dependence on selling to retail investors – virtually requires that a Schedule A bank be involved, meaning deals will have to pass the stringent vetting used by those institutions.
And many early-stage projects don’t get off the ground. Even those with good ideas and good people can run into unexpected walls.
Witness whose bid to go public last summer was put on hold until this year after the Calgary-based company faced challenging markets. Argent is in the midst of trying again, with a $325-million IPO bid. Argent is working to set up a company around prospective oil and gas land in Texas and Oklahoma.
The two other foreign asset trusts already on the market, and both of Calgary, also operate land in Texas. Eagle is looking to expand into Oklahoma, North Dakota and Montana.
But persuading markets to invest in the new trust model remains difficult.
“I think this will be a trend that proceeds selectively. I don’t currently predict a flood of issues, but there should be some,” said Mike Tims, chairman of Calgary investment bank Peters & Co. Ltd.
The fact that the foreign assets trust model is new has also created skepticism.
“I think the market is lukewarm at best on funding them,” said Jennifer Stevenson, vice-president and portfolio manager for energy with Goodman & Co. in Calgary. “So the gold rush has a brick wall.”