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Argent Leads Revival of Canadian High-Yield Trust IPOs

Argent Energy Trust, seeking to buy Texas energy assets, is leading the charge of companies planning initial public offerings in a revival of what was once a C$200 billion ($197 billion) high-yield equity market in Canada.

Argent seeks to raise as much as C$213 million in an IPO this month, one of at least six companies planning to use a new corporate structure that mimics income trusts, the high-yield securities that were curtailed by the federal government in 2006. Calgary-based Argent follows Eagle Energy Trust and Parallel Energy Trust in creating a foreign asset income trust.

“They’ve captured the attention of the market,” said Murray Lee, a tax services partner for PricewaterhouseCoopers LLP in Calgary. “There are others that are in the wings and percolating, being worked on right now.”

The new securities are attracting investors by paying dividends at about 11 percent a year when corporate bond yields have slipped to 3 percent and 10-year government debt yields reach record lows.

Like the former income trusts, foreign asset income trusts distribute part of their cash flow to investors in monthly payouts. These investment trusts differ from the earlier income trusts in that they have all their assets outside the country.

“I certainly am interested, and we don’t shy away from it just because it’s a bit different,” said Les Stelmach, who helps manage C$900 million of high dividend securities including Eagle Energy and Parallel Energy for Bissett Investment Management in Calgary. “We do like the high income and I would say there is some appeal to buying U.S. assets.”

Avoided Taxes

Income trusts were once the fastest-growing segment on the Toronto Stock Exchange, ballooning into a C$200 billion market by 2006 as firms were drawn to the tax breaks and investors were attracted to the high-yield securities. Income trusts avoided most corporate taxes by paying out most of their cash flow to investors.

That ended when Finance Minister Jim Flaherty said on Oct. 31, 2006 that the government would start taxing income trusts for the first time to level the playing field with other corporations. The move halted some C$70 billion in trust conversions including phone companies BCE Inc. and Telus Corp.

The government left an exemption in its revised rules that allowed a trust to keep its preferred tax treatment if its only income came from assets outside Canada.

‘Halloween Massacre’

“The rules are very clear: if you’re operating outside of Canada the so-called specified investment flow-through rules don’t apply,” Bob McCue, a partner with Bennett Jones LLP law firm in Calgary, said in an interview. “Those are the rules that knocked out the income trust sector, the Halloween massacre of 2006.”

The foreign asset income trust structure was concocted in Calgary more than two years ago, tapping that exemption to revamp the model that once represented about 10 percent of Canada’s stock market.

“From an investors’ standpoint, what they see is literally the same as before: an income trust that’s publicly traded that pays them a yield vehicle that owns whatever asset it happens to own,” PwC’s Lee said. “The one material difference is this line called the 49th parallel. Under the old model, pretty much everything was in Canada.”

Eagle Energy was the first of these revamped trusts, devised by Richard Clark, a securities lawyer who’s now the trust’s chief executive officer, along with McCue and Lee.

Structure Works

“It’s a structure that works, the guys have done a good job developing it,” said Mark Herman, Scotia Capital’s managing director in Calgary, who was also involved in Eagle Energy’s creation. “It’s a sector that will grow, not only in oil and gas.”

Eagle Energy raised C$170 million in its November 2010 IPO, when it sold units for C$10 each, and followed up with a C$97 million secondary sale in May. Eagle Energy, which has an 11 percent yield, traded at C$9.75 a unit at 3:58 p.m. in Toronto.

“The business has had a reasonably ambitious amount of success,” Clark, 50, said in an interview from Calgary. “We did a relatively small IPO, which I think is frankly necessary to get off the ground, and then we’ve done a separate follow-on transaction. Our goal is to be a billion-dollar enterprise 36 months after our IPO.”

Parallel Energy followed Eagle Energy’s sale five months later with its C$393 million IPO. The Calgary-based trust that invests in Texas natural gas properties trades at C$5.91 a unit, 41 percent less than its April 2011 trading debut. The decline has pushed Parallel’s dividend yield to 16 percent.

Yield Comparison

The 183-company S&P/TSX Dividend Composite Index, in comparison, has a dividend yield of 3.3 percent, according to data compiled by Bloomberg.

Bissett’s Stelmach says he’s “cautious” about the trusts, wary about any company that just focuses on pricing or yield to woo investors.

“We want to make sure we’re getting a deal that’s attractive to us, that it doesn’t try to take too much advantage of the fact that investors are interested in income,” Stelmach, 37, said in an interview. “You can’t just slap a dividend on something and bring it up to Canada.”

Other foreign asset income trusts -- including three outside the oil-and-gas industry -- are in the works.

“There are at least half a dozen right now that will be in a position to file preliminary prospectuses,” McCue, 54, said. “They’re in varying stages of development and are watching the market, trying to decide how hard they want to push forward right now when equity markets are skittish.”

Moribund IPOs

The sales would help revive a moribund IPO market in Canada. Canadian companies have raised $1 billion in initial stock sales this year, 46 percent less than a year ago and the slowest start since 2008, according to data compiled by Bloomberg.

Slumping markets kept Argent from doing its IPO earlier this year, and forced another Calgary-based company, North American Oil Trust, to withdraw plans for a C$375 million IPO in December to buy oil properties in North Dakota.

“It’s just due to market tone and confidence,” Scotiabank’s Herman said. “When institutional investors are willing to put money into new names and when retail investors feel confident, we’ll get a bunch more of these. Frankly, I’m surprised we’ve got only two.”

Argent had planned to raise as much as C$325 million in its IPO to buy energy assets in Texas and Oklahoma, but delayed the sale in June as stock markets and oil prices slumped. Argent revised its offering on July 13 after scrapping a plan to buy energy leases in Texas and Oklahoma from EnergyQuest II LLC to focus on acquiring oil-and-gas properties in Texas from Denali Oil & Gas Partners LLC.

Sales Plans

Argent plans to sell 19.1 million to 21.3 million units for C$10 each this month, according to July 16 sales documents. The trust units will have an initial yield of 10 percent to 11 percent, paid monthly, the documents show. Argent CEO Brian Prokop declined to comment.

Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Royal Bank of Canada are leading Argent’s sale.

Scotiabank is “actively” working on a couple more foreign asset income trust deals that may be ready before the end of the year, Herman said. He expects the sector to increase to 15 companies within a couple of years.

“There’s tons of demand,” Herman said. “If we got up to 10 or 12 names in the next year or two, that would not be unreasonable, but it’s all caveated by market conditions.”

Eagle Energy’s Clark says he welcomes more foreign asset income trusts.

“I think we need to have a nice asset class so that we get some following and we’ve got some peer group comparisons,” he said. “I want to have some more people to compete against.”

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