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Transcript of Changing Canadian Landscape 2006
www.bellboyd.com© 2006 Bell, Boyd & Lloyd LLC. All rights reserved.
Welcomes You.
The Changing Canadian Landscape:M&A and Private Equity Opportunities
1
Opening Remarks
Peter GainesPartner, Bell, Boyd & Lloyd LLC
2
Canadian Income Trust Market
Peter SlanManaging Director, Equity Capital Markets, Scotia Capital
Elian TernerAssociate Director, Investment Banking, Scotia Capital
- How we got to where we are- Recent tax changes- The impact of the changes- What the future holds
www.bellboyd.com© 2006 Bell, Boyd & Lloyd LLC. All rights reserved.
Overview of the Canadian Income Trust Market
December 11, 2006
4
Introduction
The Scotia Capital professionals present today are:
• Peter SlanManaging Director, Equity Capital Markets and Private Equity Sponsor Coverage
• Elian TernerAssociate Director, Investment Banking
5
Agenda
1. Income Trusts 101
2. Tax “Fairness” Plan
3. Market Outlook
4. Scotia Capital Qualifications
Note: All figures in this presentation are shown in Canadian dollars
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Income Trusts 101
7
What is an Income Trust?
• Equity investment vehicle designed to efficiently distribute pre-tax cash flow from an underlying business to investors– Shares many of the reporting, regulatory, and
governance characteristics of a common equity corporation
– Income Trust IPO valuations tended to be higher relative to a:
Sale to a financial or strategic buyer; andTraditional corporate IPO
– Canadian tax regulations did not restrict the types of businesses that could become trusts
Income Trusts 101
8
Canadian Income Trusts vs. US MLPs
• Yield structured investment vehicles
• Low cost of capital relative to corporations
• Competitive growth vehicles
• Little or no corporate tax with tax burden shifted to investors
• Majority of cash flow distributed to investors
• Yield generally a function of risk profile, growth prospects, sponsorship, and interest rate environment
Similarities
• MLPs invest in qualifying sources of income
• Income Trust structure adopted by range of businesses outside of energy sector
• Sponsors typically hold meaningful interest in fund (30 – 70%); unlike the MLP model
• Issuers can raise equity within 3 weeks through bought deal process, no market risk
• MLPs have traditionally had limited institutional investor following
Differences
Income Trusts 101
9
$0.6
$2.7
$6.7
$0.7$0.1 $0.0
$1.3
$5.3$4.4
$3.4
$5.1
$3.2
$0
$2
$4
$6
$8
$10
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006YTD
(C$
Bill
ions
)Market History
• Structure emerged in Canada in the 1980s– Widespread popularity began in the 1990s in the
REITs, Natural Resources and Power sectors
Income Trusts 101
Income Trust IPO Issuance(1995 – 2006 YTD)
Predominantly Oil & Gas, Real Estate and Power
Robust common equity market; investors focused on
Tech-based opportunities
Emergence of the “business” income trust
10
$0$25$50$75
$100$125$150$175$200$225$250
2000 2001 2002 2003 2004 2005 2006
(C$
billi
ons)
CAGR from 2000 to 2006 YTD = 47%
• Popularity driven by benefits to:– Issuers: higher valuations than common equity; widely accepted
structure; readily available acquisition financing; greater liquidity for smaller businesses
– Investors: attractive yields from operating business; tax-deferred income; liquidity of public security
Market Capitalization
Income Trust Market Capitalization(2000 – December 6, 2006) Oct 31
Dec 6
Income Trusts 101
-$26B
11
0
50
100
150
200
250
300
350
400
450
500
Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
S&P/TSX Composite Total Return IndexScotia Capital Income Trust Total Return Index ("SCITI")
(Inde
xed
to 1
00 a
t Jan
uary
3, 2
000)
73%
298%
Relative Performance
Relative Performance(2000 – December 6, 2006 YTD)
Income Trusts 101
Oct-31
• Income Trusts significantly outpaced the broader equity market
12
Size and Diversity
• Currently 250 income trusts with a total market capitalization of $201 billion or 12.8% of the S&P/TSX Composite Index– Most trusts have adopted a “wait and see” attitude
before committing to a structural change
Composition of Income Trust Market(December 6, 2006)
Income Trusts 101
Consumer Products
$26.4
Utilities & Infrastructure
$19.5 Energy$65.7
Industrials$33.2
Resources$21.3
Real Estate$28.0
Power Generation
$7.3
13
Attractive Risk Return ProfileIncome Trusts 101
Risk vs. Return(January 1, 1995 – December 6, 2006)
• Trusts offer higher returns with lower risk to investors
SCITI
S&P/TSX Composite Index
0%
5%
10%
15%
20%
0% 2% 4% 6% 8% 10% 12% 14% 16% 18%
Standard Deviation of Daily Returns Annualized
Aver
age
Dai
ly R
etur
ns A
nnua
lized
Increasing Risk
Incr
easi
ng R
etur
n
14
Current SituationIncome Trusts 101
• On October 31, 2006 the Canadian Government announced a Tax “Fairness” Plan aimed at eliminating the tax advantages enjoyed by income trusts
• Trust market capitalization of $226 billion
• 11% of the TSX• Fastest growing segment of the
Canadian capital markets• Growth accelerating with several recent,
large Telecom deals along with other sizeable conversions expected in the Oil & Gas sector
• No “double-taxation” on corporate profits
Before
• Steep decline in valuations• Short-term investors have moved
money out of the sector• Investor demand for yield remains
strong, forcing investors to look for alternative investments
• Trusts are evaluating alternatives (converting to corporate structure; going private; divestitures and defense strategies)
• Corporate profits potentially subject to “double-taxation”
After
15
Market Reaction to Tax “Fairness” Plan
Performance of Scotia Capital Income Trust Index(November 1 – December 6, 2006)
Income Trusts 101
• There was a wholesale revaluation of the income trust sector following the announcement
Since Nov 1 -10.5%
1,980
2,030
2,080
2,130
2,180
2,230
2,280
2,330
2,380
2,430
1-Nov 6-Nov 11-Nov 16-Nov 21-Nov 26-Nov 1-Dec 6-Dec
Inde
x Le
vel
16
Valuation Decline Varies by Sub-Sector
• Primary valuation benchmarks have become corporate multiples (e.g. EV/EBITDA, P/CF)
• Valuation factors include: tax status post 2011, four year transition period, pre and post tax yield at investor level
Average Price Change by Sub-Sector (Since November 1, 2006)
Income Trusts 101
-17.3%-15.0% -14.2% -13.5% -13.4%
-5.9%
4.3%
-20%
-15%
-10%
-5%
0%
5%
10%
Energy Consumer Power Utilities andInfrastructure
Industrials Resources REITs
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Tax “Fairness” Plan
18
Political Landscape
• Canadian Government has examined the income trust structure several times in the past– Tax “Fairness” Plan definitively halted any planned
income trust IPOs and conversions
Tax “Fairness” Plan
March 23, 2004
Budget tabled with proposals which
were later rescinded
Fall, 2003
Discussions with market
participants
Fall, 2005
Formal consultation process resulted in status quo for trusts
October 31, 2006
“Tax Fairness Plan”announced
20042003 2005 2006
19
Summary of Tax “Fairness” Plan
• Key Measures– Tax on distributions from publicly-traded income trusts and limited
partnerships– Modest reduction in general corporate income tax rate
• Simplified Explanation of Changes– Effective 2011, trusts will be taxed like corporations – Trusts will no longer be able to deduct income distributions to
unitholders – Income distributions will be taxed as the unitholder level at the
same rate as corporate dividends– Distributions that are classified as “return of capital” for tax
purposes (i.e. distributions in excess of taxable income) will NOT to be taxed at trust or investor level
Tax “Fairness” Plan
20
Timeline
• Immediate Implementation– Measures effective 2007, but are implemented immediately
• Four-Year Transition Period– Government proposing four-year transition period for publicly-
traded trusts and limited partnerships existing on October 31, 2006
– For income trusts or publicly-traded flow-through entities that begin trading after October 31, 2006, these measures will apply starting in the 2007 taxation year
• Compliance– The government will monitor existing trusts during transition
period to assess “new avoidance techniques” and “undue expansion”
Tax “Fairness” Plan
21
Changes to Taxation of Income Trusts• Changes are directed at:
– “Tax-deferred” Canadian investors (RSP, pension funds); and – Foreign holders of income trusts
• These investors were not affected by the changes enacted in 2005
Comparison of Investor Tax Rates – Current vs. 2011
Tax “Fairness” Plan
2011
CurrentCorporate
2011
CurrentIncome Trust
41.5%31.5%45.5%Total 201110.0%0.0%14.0%Personal Level31.5%31.5%31.5%Income Trust Level42.0%34.0%50.5%Total Current10.0%0.0%16.5%Personal Level34.0%34.0%34.0%Income Trust Level
41.5%31.5%45.5%Total 201110.0%0.0%14.0%Personal Level31.5%31.5%31.5%Income Trust Level0.0%0.0%46.0%Total Current15.0%0.0%46.0%Personal Level0.0%0.0%0.0%Income Trust Level
Tax-DeferredCanadian
Taxable U.S. Investor
Taxable Canadian
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Market Outlook
23
New Landscape Presents Opportunity
• Business trusts can be divided into two segments:– “Healthy” trusts
Underlying business performing well; value impacted by recent Government announcementInvestors are currently assessing the long term impact and considering short term opportunities
– “Troubled” trustsPrior difficulties with business performance; value declines have been magnified by recent Government announcementInvestors have been struggling to find value and liquidity in these trusts
Market Outlook
• Both “Healthy” and “Troubled” trusts may now be considered as acquisition targets
24
Transaction Alternatives
• Trusts convert back to corporate structure– With or without four year grandfathering
• Mergers/Acquisitions– Private equity and financial buyers pursue targets as
valuations have declined– Strategic buyers see new / more opportunities given
overall decline in valuation
Market Outlook
25
M&A Landscape
• Many trusts lack the size or liquidity to benefit from remaining public• Corporations will be better positioned to complete strategic
acquisitions of income trusts– Income trusts’ cost of capital advantage has eroded
• Private equity sponsors are showing increased interest in going private transactions– Record levels of private equity capital raised – Robust leverage market with historically low interest rates
• Greater shareholder activism – Hedge funds forcing companies to initiate sale processes
• Fewer structural take-over defenses available in Canada– Limited life of poison pills – Limited effectiveness of “just say no” defense
Market Outlook
26
Issues for Consideration
• Straight Takeover of All Units
• Acquisition of Underlying Business
• Review Declaration of Trust
• Understand Rights of Retained Interest Holders
• Potential for Hostile Transactions
Market Outlook
27
Lowest Trading Multiples by Segment
Consumer Products
Utilities
Industrial Products
Communications, Media & Technology
Market Outlook
LTM EV/EBITDA Change in Multiple EV as of:12/6/2006 Since 10/31/2006 12/6/06
Peak Energy Services Trust 4.3x -1.8x $201Tree Island Wire Income Fund 4.7x -1.6x $150Vicwest Income Fund 4.8x -3.2x $203TerraVest Income Fund 5.0x -0.8x $195Impax Energy Services Income Fund 5.0x -0.8x $132Total Energy Services Trust 5.2x -0.3x $395Gienow Windows & Doors Income Fund 5.2x 0.0x $172Builders Energy Services Trust 5.2x -0.9x $262Bird Construction Income Fund 5.6x -0.2x $142Trimac Income Fund 5.6x -0.8x $253
LTM EV/EBITDA Change in Multiple EV as of:12/6/2006 Since 10/31/2006 12/6/06
E.D. Smith Income Fund 6.2x -3.0x $188Clearwater Seafoods Income Fund 6.3x -0.5x $418The Brick Group Income Fund 6.3x -1.3x $497VOXCOM Income Fund 6.6x -0.5x $132Stephenson's Rental Services Income Fund 6.7x -0.6x $117Keystone North America Inc. 7.2x -0.6x $200Ag Growth Income Fund 7.2x -1.7x $170UE Waterheater Income Fund 7.2x -0.8x $1,060Golf Town Income Fund 7.2x 0.9x $177Sterling Shoes Income Fund 7.6x -0.5x $101
LTM EV/EBITDA Change in Multiple EV as of:12/6/2006 Since 10/31/2006 12/6/06
Entertainment One Income Fund 4.8x -0.5x $129Cinram International Income Fund 5.2x 0.1x $1,995Custom Direct Income Fund 5.5x -0.6x $168Bell Aliant Regional Comm. Income Fund 6.3x -1.0x $9,403The Data Group Income Fund 6.3x -1.5x $282Supremex Income Fund 6.4x -0.9x $320Amtelecom Income Fund 6.6x -0.6x $105FP Newspapers Income Fund 7.7x -0.1x $203Movie Distribution Income Fund 7.7x 0.0x $409Osprey Media Income Fund 8.0x -1.0x $421
LTM EV/EBITDA Change in Multiple EV as of:12/6/2006 Since 10/31/2006 12/6/06
Parkland Income Fund 4.9x -0.6x $350Gaz Metro LP 8.3x -0.8x $3,069Superior Plus Income Fund 8.4x -1.0x $1,598Fort Chicago Energy Partners L.P. 8.9x -0.4x $2,901Taylor NGL LP 10.0x -0.9x $501Enbridge Income Fund 10.1x -0.9x $1,896AltaGas Income Trust 10.5x -0.6x $1,775Keyera Facilities Income Fund 10.9x -2.1x $1,374Inter Pipeline Income Fund 10.9x -1.5x $2,343Pembina Pipeline Income Fund 13.6x -1.2x $2,477
For trusts with Enterprise Values greater than $100 million
28
• We believe a mid-cap high yield common equity market will likely develop in Canada
– Greater transparency with specific policies on dividends and payout ratios– Yields of 4-6% versus 1-3% for Corporates and 8-10% for Income Trusts– Higher leverage– Larger offerings
IPOs in CanadaMarket Outlook
S&P/TSX Composite Dividend Paying Stocks
1 0 3# Issuers 107 22 17 16 8 15 5 4 2
$0
$50
$100
$150
$200
$250
$300
$350
$400
0.0% -0.5%
0.5% -1.0%
1.0% -1.5%
1.5% -2.0%
2.0% -2.5%
2.5% -3.0%
3.0% -3.5%
3.5% -4.0%
4.0% -4.5%
4.5% -5.0%
5.0% -5.5%
5.5% -6.0%
Dividend Yield Range
Mar
ket C
apita
lizat
ion
(C$
billi
ons)
Income Trust Yields by Sub-Sector
0%
5%
10%
15%
20%
25%
30%
35%
PowerGeneration
Real Estate Utilities &Infrastructure
Resource ConsumerProducts
Industrials Energy
(Run
ning
Yiel
d)
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Scotia Capital Qualifications
30
About Scotia Capital
• Wholesale division of Scotiabank:– Canada’s top performing bank in the past 10 years– Canada’s third largest public company– Canada’s most international bank - 56,000 employees
in more than 50 countries• 1,200 employees in 18 offices worldwide• Two business units serving clients in Canada, the U.S.,
Mexico, Europe and Asia
Scotia Capital Qualifications
31
About Scotia Capital
• Corporate Banking
• Investment Banking• Canada, U.S., Mexico
• Mergers & Acquisitions
• Oil & Gas M&A (Scotia Waterous)
• Equity Capital Markets
• Canadian Relationship Management
• Loan Portfolio Management
Global Corporate & Investment Banking
• Capital Markets Group• Derivatives & Fixed Income• Domestic Money Market
• Foreign Exchange
• Precious Metals (ScotiaMocatta)
• Institutional Equity
• Equity & Debt Research
Global Capital Markets
32
Best Investment Bank in Canada
“We’re not just picking the biggest banks, we are choosing the best, based on profitability, financial strength, as well as quality of staff dedicated to investment banking”
- Global Finance Magazine
Voted Best Investment Bank in Canada for 2004, 2005 and 2006 by Global Finance
Scotia Capital Qualifications
33
Masonite/KKR Case Study• On December 22nd, 2004, KKR announced
the acquisition of Masonite for C$40.20 in cash• Scotia Capital was exclusive financial advisor to KKR• The transaction was financed with a combination debt
and equity:– Senior debt of US$1.55 billion:
Term B facility of US$1.2 billion with a term of 8 yearsRevolver of US$350 million (undrawn at closing)
– Bridge financing of $770 million– Equity component of US$650 million to be injected
by KKR
Scotia Capital Qualifications
• Scotia Capital underwrote 100% of the total debt requirement• Scotia Capital acted as lead arranger for the revolver and Term B facility• Scotia Capital acted as the co-bookrunner and co-lead on the high yield
financing
34
IPO Mandates for Financial SponsorsStrong track record of delivering results for financial sponsors
Scotia Capital Qualifications
Company IPO Size Scotia Capital Role Financial Sponsor(s) (C$ mm)
$70.1 • Sole Bookrunner on IPO
$41.9 • Sole Bookrunner on IPO
$77.0 • Co-Lead Manager on IPO • Lead Commercial Bank • Co-Led Corporate Borrowing
$54.6 • Lead Bookrunner on IPO
$187.7 • Co-Lead Manager on IPO
$202.9 • Joint Bookrunner on IPO • Lead Commercial Bank
35
Company IPO Size Scotia Capital Role Financial Sponsor(s) (C$ mm)
$73.8
• Co-Bookrunner on IPO • Lead Commercial Bank • Hedging Instruments • M&A Advisory
$90.2 • Lead Manager on IPO • Corporate Lender • M&A Advisory
$74.0 • Lead Manager on IPO
$204.0 • Co-Lead Manager on IPO • Senior Corporate Lender • M&A Advisory
$194.0
• Co-Lead Manager on IPO • Co-Led Secondary Offering • Co-Led Corporate Lending • M&A Advisory
$1000.0
• Co-Lead Manager on IPO • Co-Led MTN Offering • Corporate Lender • Co-Led Multiple Follow-On Offerings
IPO Mandates for Financial SponsorsScotia Capital Qualifications
36
Company IPO Size Scotia Capital Role Financial Sponsor(s) (C$ mm)
$135.2 • Co-Lead Manager on IPO • Corporate Lender
$105.7 • Lead Manager on IPO • Led Secondary Offering
$164.4 • Co-Lead Manager on IPO • Co-Led Secondary Offering • Corporate Lender
$102.0 • Co-Lead Manager on IPO • Co-Led Secondary Offering • Corporate Lender
$89.5 • Co-Lead Manager on IPO
$151.0
• Sole Lead Manager on IPO • Co-Led Secondary Offering • Lead Corporate Lender • M&A Advisory
Livingston International Income Fund
IPO Mandates for Financial SponsorsScotia Capital Qualifications
37
Advisory Mandates for Financial SponsorsScotia Capital Qualifications
Acquiror
Target Deal Size Scotia Capital Role Financial Sponsor(s) (C$ mm)
$1,000.0 • Financial Advisor to CPP
$3,200.0 • Exclusive Financial Advisor to KKR
n/a • Exclusive Financial Advisor to United
$75.0 • Exclusive Financial Advisor to United
$19.0 • Exclusive Financial Advisor to PNG
$193.5 • Financial Advisor to Osprey
$25.0 • Exclusive Financial Advisor to Haley
$220.0 • Exclusive Financial Advisor to Osprey
Formerly 843504 Alberta Ltd.
and
11 Office Towers from
Community Newspaper from
38
Peter Slan, Managing Director, Equity Capital Markets and Private Equity Sponsor Coverage
• Peter joined Scotia Capital in 1997 and has a wide range of investment banking experience across different industry groups and product areas, with a particular focus on income trusts. He has advised several entrepreneurs and private equity firms on initial public offerings and other equity financings, and many public companies on acquisitions, divestitures and financing transactions.
• Prior to joining Scotia he practiced for several years with Ernst & Young LLP in Toronto. He is a Chartered Accountant and holds an MBA degree from the Rotman School of Management at the University of Toronto.
39
Elian Terner, Associate Director, Investment Banking
• Since joining Scotia Capital in 2001, Elian has been actively involved in numerous debt and equity offerings. As a member of the Industrial Products group in Investment Banking, Elian focuses primarily on industrial equipment, transportation, and construction and engineering companies.
• Prior to joining Scotia Capital, Elian practiced law with Weil Gotshal & Manges in New York City, where he specialized in structured finance securities offerings in the U.S. and abroad. Elian received his Bachelor of Commerce (Distinction) from the University of Toronto, and his Bachelor of Laws degree from Osgoode Hall Law School of York University.
40
Acquiring Canadian Income Trusts or their Underlying Businesses–Legal Issues
Stephen ErlichmanPartner, Fasken Martineau Dumoulin LLP
•- What is an income trust?•- Rights, remedies and other legal considerations•- Acquisition techniques
41
Canadian Income Trusts: Some Non-Tax Legal Considerations for U.S. AcquirersA. What is this thing Canadians call an income trust?B. Rights, Remedies and other Legal Considerations
a) Requisitioning a Unitholder Meetingb) Obtaining a List of Unitholdersc) Compulsory Acquisitions: 90% Squeeze Outd) Other Corporate Acquisitions Methodse) Oppression and Other Statutory Rights and
Remediesf) Underlying Entity Considerationsg) Income Trust Governance Project of the Canadian
Coalition for Good Governance
42
Canadian Income Trusts: Some Non-Tax Legal Considerations for U.S. AcquirersC. Acquisition Techniques
a) Hostile Acquisitionsb) Friendly Acquisitions
D. Conclusion
Stephen I. Erlichman (LL.M. (New York), M.B.A. (Harvard)) is a senior partner at Fasken Martineau DuMoulin LLP in Toronto with a broad corporate and securities practice. He can be reached at 416-865-4552 or by email at [email protected].
43
Acquiring Canadian Income Trusts or their Underlying Businesses–Tax Issues
Kathleen HanlyPartner, Fasken Martineau DuMoulin LLP
Ron ChoudhuryAssociate, Fasken Martineau DuMoulin LLP
•- Assets vs. units•- Resident, non-resident and tax-exempt Unit holders•- Tax-effective acquisition strategies
Acquiring Canadian Income Trusts or the Underlying Businesses – Tax Issues
Kathleen S.M. HanlyRon Choudhury
45
Overview
• Typical income trust structures• Changes to tax treatment of income trusts• Purchase of income trust• Purchase of operating assets• Reverse hybrid acquisition structure
46
Typical Income Trust Structures – Fund on Corporation
Fund
Canco
Retained Interest Holders
ExchangeableShares
Operations
Senior Debt
Subordinated Notes Common Shares
Unitholders
Interest on Notes minimizes Canco income subject to tax –Necessary because Canco taxable entity (not flow-through)
Fund is flow-throughentity for tax purposes
Canco acquired assets at historical tax basis
47
Typical Income Trust Structures – Fund on Sub-Trust on Limited Partnership
ExchangeableLP Units
Senior DebtLimited Partnership
Sub-Trust
Fund
Retained Interest Holders
Operations
Ordinary LP Units GP Interest (0.01%)
GP Co
Units and Notes
Unitholders
Both Sub-Trust and Limited Partnership are flow-through entities – Income taxed at Unitholder level
LP acquired assets at historical tax basis
48
Changes to Tax Treatment of Income Trusts
• Before new rules, income trust (Fund) treated as non-taxable flow-through vehicle
• New rules treat income trusts like corporations• Tax burden on non-residents and tax-exempts
investing in corporation and income trust will be the same
49
Changes to Tax Treatment of Income Trusts (cont’d)
• Under new rules, ≥ 2011:• Existing income trust earning business income (directly
or indirectly) taxed like corporation • Fund distributions taxed as dividends
• New income trust subject to these rules in 2007 (effectively eliminating new income trusts)
50
Exceptions
• Portfolio investment funds not affected • REITs not subject to new tax regime but “REIT”
narrowly defined• Must meet Canadian content and passive investment
requirements• Hotel and retirement REITS do not qualify
51
Purchase of Income Trust – Issues
• Tax treatment to Unitholders vs. Buyer• Tax basis of Units held by Canadian resident
taxable investors relative to fair market value (“FMV”)
• Tax basis of operating assets in Canco/LP relative to FMV – generally low tax basis due to prior vendor roll-in
52
Purchase of Income Trust – Issues (cont’d)
• Usual dynamic• Optimizing tax treatment to Unitholders generally
results in less tax shield to Buyer• Goes to pricing
• Asset purchase more attractive to Buyer from non-tax perspective because no contingent liabilities
53
Purchase of Fund
Limited Partnership
Sub-Trust
FundUnitholders
Buyer
Cash
Canco
Buyer acquires Unitsfrom Unitholdersfor cash
54
Purchase of Fund (cont’d)
• Canadian resident capital account Unitholdershave capital gains treatment• ½ of gain (proceeds less tax basis of Units) included in
income as taxable capital gain• Capital gain therefore taxed at ½ rate applicable to
ordinary income
∴
55
Purchase of Fund (cont’d)
• Non-resident Unitholders generally exempt from Canadian tax on gain
• Canadian pension funds and other tax-exempts also receive proceeds free of tax
56
Purchase of Fund (cont’d)
• Buyer gets no step-up in tax basis of underlying business assets (assuming their FMV exceeds their tax basis)
• Buyer is able to match interest expense on acquisition debt with operating income by• Merging with Canco, or• Leaving Sub-Trust/LP structure in place because Sub-
Trust and LP are flow-throughs
57
Purchase of Fund (cont’d)
• Can’t collapse Sub-Trust/LP if accrued gain because no rollover• Rollover rule may be introduced in subsequent
legislation to facilitate elimination of Sub-Trust/LP
• Purchase of Fund means Buyer assumes contingent and other liabilities, including those relating to taxes• E.g. interest rate on internal debt in Canco structure
58
Purchase of Operating Assets
FundBuyer
CancoOperating
Assets
Cash Cash
Limited Partnership
Sub-Trust
Fund
Buyer acquires operating assets for cash
Canco pays tax on income realized on sale –After-tax proceeds paid to Fund as returnof capitalization and dividend
Income realized by LP onsale flowed out to Unitholders for tax purposes
59
Purchase of Operating Assets (cont’d)
• Under Canco structure• Canco pays tax on any income on sale (including
recapture and ½ of goodwill gains and capital gains)• Canco pays after-tax proceeds to Fund as return of
capital, repayment of notes and dividend
• Canadian taxable investor pays tax on dividend and has capital gain equal to rest of proceeds received on wind-up of Fund less tax basis of Units
60
Purchase of Operating Assets (cont’d)
• Canadian taxable investors bear more tax on Canco asset sale than on sale of Units if tax on ordinary income at Canco level
• Expect Canco will pay tax on asset sale because acquired assets at vendor tax basis when income trust created
61
Purchase of Operating Assets (cont’d)
• If LP realizes income on asset sale, Unitholders taxed on that income (other than capital gains)
• Expect LP will have income on sale due to low tax basis of assets
• Any additional proceeds (i.e. in excess of LP allocated income) received by Canadian taxable Unitholders on wind-up of Fund less tax basis of Units is capital gain
62
Purchase of Operating Assets (cont’d)
• Non-resident Unitholders taxable on Canco dividend/income realized by LP (other than capital gains)• 15% withholding rate for US residents entitled to treaty
benefits → less attractive than tax-free gain on sale of Units
• Remaining proceeds tax-free capital gain
63
Purchase of Operating Assets (cont’d)
• Canadian pension funds and other Canadian tax-exempt Unitholders receive proceeds free of tax in both Canco and LP asset sale scenarios
• However, greater tax burden on tax-exempts under Canco structure relative to LP structure since• Canco pays tax on asset sale • In LP structure proceeds allocated to Unitholders for
tax purposes
64
Purchase of Operating Assets (cont’d)
• Assets of operating business acquired by Buyer at stepped-up FMV• New tax basis can be amortized by Buyer in case of
depreciable property and goodwill• Again, quid pro quo is higher purchase price because
less attractive treatment to Unitholders
65
Purchase of Operating Assets (cont’d)
• Buyer does not inherit cumbersome Sub-Trust/LP structure• Corporation usual vehicle for businesses • Corporation more flexible for subsequent
reorganizations etc.
• No assumption of contingent liabilities
66
Tax Treatment of Losses
• If there are losses, Canadian taxable Unitholders may prefer to realize loss on sale of Units so that can use loss to shelter capital gains
• Loss on asset sale in Canco or Fund cannot be flowed out to Unitholders
• May have Unitholders with losses but gain on operating assets in Canco/LP because of initial roll-in
67
Reverse Hybrid Structure
• Defer recognition of interest paid by Canadian operating entity for US tax purposes• Relative to conventional leveraged buy-out, “benefit” is
deferral of interest income for US tax purposes
• Next Canada-US protocol may deny treaty benefits to US investors in reverse hybrid• Need to invest e.g. through Luxco – see Article 1(6) of
US model convention
68
Reverse Hybrid Structure (cont’d)Partnership = corporationfor US tax purposes, flow-through entity for Canadian tax purposes –Means income blocked for US tax purposes
Buyer
NSULC
NSULC = flow-through entity for US tax purposes, corporation for Canadian tax purposes
Fund
Senior Debt
Maximize internal leveragewithin 2/1 debt/equitythin cap restrictions –Leveraged equity
Defer interest recognition for US tax purposes –May need to invest through Luxco
69
Speakers
Kathleen Hanly• Tax Partner, Director of Toronto Tax Group• Board of Governors, Canadian Tax Foundation• Hons. B.Sc. Physics, University of Toronto• LL.B., University of Toronto
70
Speakers (cont’d)
Ron Choudhury• Tax Associate• B.A. Economics, University of Toronto and
Hons. B.A. English, University of Calcutta• LL.B., Osgoode Hall Law School• LL.M., New York University
72
Canadian Private Equity Landscape
Michael LockeManaging Director and Head, Private Equity Sponsor Coverage Group, Scotiabank
- Canadian Economy- Canadian Private Equity Landscape- Scotiabank – Private Equity Sponsor Coverage Group
Canadian Private Equity Landscape
December 11, 2006
74
Introduction
• Michael Locke Managing Director and Head,
Private Equity Sponsor Coverage Group
75
Agenda
Canadian Economy
Canadian Private Equity Landscape
Leveraged Buyout Market
Scotiabank – Private Equity Sponsor Coverage Group (“PESCG”)
Questions and Answers
Canadian Economy
77
Canadian Economy
US and Canada key indicators show similar trends
Source:Statistics Canada, Scotia Economics
GDP
% YoY GDP Growth
Interest Rates
%
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
1987 1989 1992 1994 1997 1999 2002 2004 2007
Canadian GDP US GDP
forecastforecast
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
1997 1999 2002 2004 2007
Bank of Canada Target Rate Federal Reserve Target Rate
forecast%%
78
Canadian Economy
Canadian Dollar has been gaining strength against US Dollar
Source: Bloomberg, Scotia Economics
USD/ CAD
0.600.650.700.75
0.800.850.900.95
1987 1989 1992 1994 1997 1999 2002 2004 2007
Canadian Dollar Exchange Rate
1987 onwards
forecastUSD/CAD
Canadian Private Equity Landscape
80
Canadian Private Equity Landscape
• Canadian private equity and venture capital provides a vital source of finance for growing companies across all industry sectors
• The PE industry provides long-term investment capital
contributing to sustainable economic growth
generating employment
financing new research and technologies
supporting Canada’s promising growth companies
• The PE industry operates according to accepted standards of:
conduct
reporting
valuation
• The PE industry has a strong network of professional advisors to support its increasingly important role in the Canadian economy.
Source:CVCA
Market Overview
81
Private Equity market is maturing
Source: Scotia Capital
• The Canadian private equity market has continued to mature following a proliferation of new funds established during the last five years
• A majority of the funds raised during the last five years are now nearing the end of their lives
• Virtually all of the funds have been fully invested
• Many funds have been able to realize significant returns:
The lack of competition in the Canadian market during the early years of the funds led to several companies being acquired at low multiples
Strong public markets has led to increased valuations upon the exit of businesses
• The income trust market in particular provided an effective vehicle for exiting businesses at unexpectedly high multiples, including:
Torquest’s IPO of Granby Industries (EV/EBITDA 8.7x)
Imperial Capital’s IPO of E.D. Smith (EV/EBITDA 9.8x)
Edgestone Capital’s IPO of BFI (EV/EBITDA 7.0x)
Clairvest’s IPO of Gateway Casino’s (EV/EBITDA 8.6x)
ONCAP’s IPO of FutureMed (EV/EBITDA 9.4x)
Tricor Pacific’s IPO of Tree Island Wire (EV/EBITDA 7.6x)
Canadian Private Equity Landscape Market Overview
82
Canadian Private Equity Landscape
Private Equity capital under management reached $56 billion in 2005 in Canada
Source: Thomson MacDonald
Buyout52%
Venture37%
Mezzanine11%
Capital Under Management by Market Segment
(FY 2005)
Capital Under Management by Investor
(FY 2005)
Private Independent
39%
Institutional30%
Retail20%
Corporate6%
Government5%
Capital Under Management
83
New Fund Raising PE Funds Raised
Fund raising is increasing
Source: Scotia Capital
• Many private equity firms have raised new funds in the last 12 months
• Significant investment returns have permitted many private equity firms to substantially increase the size of their funds:
• Furthermore, the high returns have attracted several new private equity firms into the market:
• Large pension funds are allocating more funds to direct private equity investments (OMERS, Teacher’s, CPP)
Fund Name Previous Fund (mm) New Fund (mm) % Increase
Torquest $180 $550 206%ONCAP $400 $575 44%Tricor Pacific $235 $490 109%CAI $195 $375 92%Kilmer $115 $250 (target) 117%Birch Hill n/a $850 nmf
Richardson $325 $720 121%
Novacap $210 $400 90%
Edgestone $360 $800 122%
Fund Name Fund Size (mm)
Canterbury Park $150
Whitecastle $55
Perseis $375
84
$0
$2,000
$4,000
$6,000
$8,000
$10,000
2002 2003 2004 2005 Q3 2006
Buyout Funds Mezzanine Funds Venture Capital Total
Fund raising is in high gear
• Almost $8 billion has been raised YTD
Buyout funds have raised the majority of capital
Source: Thomson MacDonald
Canadian Private Equity Fund Raising
(FY 2002 – YTD)
Canadian Private Equity Landscape
CAN $, billions
PE Funds Raised
85
Foreign Sources32%
Corporations22%
Pensions34%
Individuals7%
Insurance Companies
5%
Other0%
100% = CAN $1.7 billion
Sources of funds are diverse
Canadian Private Equity Landscape
Source: Thomson MacDonald
Source of Buyout and Mezzanine funds raised
2005
PE Funds Raised
86
2.33
2.1
4.3
6.4
0.9 10.7
1.2 1.2
0
1
2
3
4
5
6
7
2001 2002 2003 2004 2005Buyout Mezzanine
Canadian Private Equity Landscape
Buyout and Mezzanine capital invested by Canadian Private Equity Funds
CAN $, billions
Source:MacDonald & Associates, Thomson Venture Economics, CVCA
Investment of Buyout and Mezzanine Capital
2001-2005
Investment of PE Capital
87
100% = CAN $7.63 billion
Financing opportunities are many
Canadian Private Equity Landscape
Source: Thomson MacDonald
Buyout and Mezzanine Funds invested by event type
2005
Acquisition47%
MBO28%
Restrucutring/ Other10%
Expansion9%
Refinancing6%
Investment of PE Capital
88
Canadian Private Equity Landscape
Highlights of foreign Private Equity activity in Canada
Hudson’s Bay Co. Intrawest Corp
Fairmont Hotels & Resorts Four Seasons Hotels Inc.
Foreign Acquisitions of Canadian Companies
2006
PE Activity
Source: Thomson Financial (www.canadavc.com)
89
Canadian Private Equity Landscape
• Canadian companies acquired by global strategic or private equity investors
Falconbridge of Sudbury, Ont., is acquired by Swiss-based Xstrata for $18 billion
Houston-based Kinder Morgan Inc. buys Vancouver-based utility company Terasen Inc. for $6.9 billion
Hamilton steelmaker Dofasco is bought for $4.7 billion by Luxembourg-based Arcelor SA
Graphics chip-maker ATI Technologies of Markham, Ont., is sold to California-based Advanced Micro Devices Inc. for $5.34 billion US
Vincor, Canada's largest winemaker, sold to N.Y.-based Constellation Brands for $1.1 billion
Sleeman Breweries of Guelph, Ont., bought by Japan's Sapporo Breweries for $400 million
Nickel giant Inco bought by CVRD of Brazil for approximately $19 billion
And Montreal-based paper-maker Domtar has agreed to a $3.3-billion merger with a unit of U.S. paper giant Weyerhaeuser.
High profile Canadian buyout opportunities
Source: CBC News
Investment Activity
90
Canadian Private Equity Landscape
Source: Thomson McDonald
Cross-border deals are common
Sentinel Capital Partners
MckennaGale
Acquisition of
Nanaimo’s Madill Equipment(Major Manufacturer of Specialty Equipment)
17 million
Sub-Debt and EquityCanada USA
2005
Cross Border PE Activity
91
Canadian Private Equity Landscape
Source: KKR website
KKR has invested $1.2 billion equity in Canadian transactions
Canadian General Insurance
Shopper’s Drug Mart
Yellow Pages Group
Masonite
Kohlberg KravisRoberts & Co.
Since 1995
Cross border PE Activity
92
Canadian Private Equity Landscape
Source: MacDonald & Associates Ltd, Thomson Venture Economics, CVCA and NVCA
Canadian Private Equity market has been delivering superior returns
8.10%
3.60%
8.80%
21.10% 20.10%21.50%
Three Years Five Years Ten Years
U.S. Canada
Private Equity Returns (Buy out and Mezzanine)
All periods ending December 31, 2004
PE Returns
93
• State of Private Equity Market Balance in Canada
• Institutional Pools1 =$ 56 billion
• Private Pools2 =$ 5 billion
• 10% allocation from all Canadian Institutional Investors =$100 billion
• US/International funds only interested in large deals
Bid Side/ Sources
• Canadian Assets3 =$1.2 trillion
• Foreign Assets4 =$1.0 trillion
Ask Side/ Uses
Canadian Private Equity Landscape
Source: Kensington Analysis, May 2006
Numbers do not support the notion that too much money is chasing too few deals
$60 to $100 billion $1.5 to $2 trillion
PE Market Size Estimate
Note: Business Assets poised to change hands by 2010
(1) Goodman and Carr LLP 2005 Private Equity Report(2) Kensington Capital Estimate(3) CIBC World Markets – February 2005(4) Globe and Mail Estimate
94
Market Outlook
Opportunities are plenty
• Private Equity firms are now finding it considerably more difficult to make purchases at attractive multiples
Increased competition between sponsors
Public market alternatives have provided vendors with a meaningful valuation signal
• Furthermore, the current liquidity in the lending markets has led to ever larger leveraged buyouts
Many new participants in the Canadian leveraged loan market are driving leverage up
• Most private equity firms are, therefore, facing a particularly challenging market environment where valuations have risen but they have more dollars to put to work
Relentless focus on acquisitions
Dispositions usually only to facilitate the wind-down of a fund nearing the end of its term
• Nonetheless, the elimination of the income trust market will reduce exit multiples for sponsors
Existing income trusts may have to trade at discounts to their corporate company comparables before becoming compelling investment opportunities
Canadian Private Equity Landscape
Source: Scotia Capital
95
Canadian Private Equity Landscape
Canadian Leverage Buyout market
• Buyout industry will continue its growth
• Mature industry characteristics:
Bigger player to consolidate and focus on institutionalizing their capabilities
• Huge Leverage Buyout opportunity – more than a trillion Canadian dollars are expected to change hands due to succession issues
Source:CVCA
Market Outlook
96
Canadian Venture Capital Association (CVCA)
• Established in 1974, the CVCA is dedicated to pursing growth opportunities for the Canadian venture capital and private equity industry
• CVCA members represent over $50 billion in capital under management
• Over 1,100 members comprised of:
venture capitalists
institutional investors
corporate investors
private equity investors
angel investors
advisory members which provide services such as law, finance, executive search, consultants
investment banks
insurance companies
academia
Canadian Private Equity Landscape Industry Association
Source:www.cvca.ca
97
Canadian Private Equity Landscape
The Canadian Private Equity market is underserved
Private Equity Capital / GDP Private Equity Capital / Public Market Value
2.00%
4.80%
0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00%
Canada
US
2.40%
5.20%
0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00%
Canada
US
Source: MacDonald & Associates Ltd, Thomson Venture Economics, Statistics Canada and Bureau of Economic Analysis
Why Canada
98
Why Canada
UK Australia CanadaUSA
Excellent Private Equity Environment
Canada ranked fourth globally
Source: Apax Partners and Economic Intelligence Unit
Canadian Private Equity Landscape
Scotiabank - PESCG
100
Michael Locke
Corporate Credit Department, Toronto
International Project Finance, Toronto
Corporate Banking, New York & San Francisco Agency
Vice President and Head of Corporate Banking, Toronto
Managing Director and Head of the Industrial Products Group of Scotia Capital
Vice President - Commercial Banking at the flagship Scotia Plaza branch
Area Vice President for the Commercial Bank's Greater Toronto Area
Managing Director and Head – Private Equity Sponsor Coverage Group
BA in Economics and Political Science
from Glendon College (Bilingual Program) of York University
MBA from the Schulich School of Business at York University
Graduate of the Stanford Executive Program
of the Graduate School of Business at Stanford University
Biography
101
(416) [email protected]
Ashutosh ChauhanAssociate
(416) 866-6420 [email protected]
Jeff Snowden Associate
(416) [email protected]
Christine MacInnesAssociate
(416) [email protected]
Doug PettenAssociate Director
(416) 866-5651 [email protected]
William (Nick) DinkhaAssociate Director
(416) [email protected]
David TorreyDirector
(416) [email protected]
Paul Hodgson Director
(416) [email protected]
Michael Locke Managing Director & Head
Phone/ EmailName/ Designation
Contact List
Questions and Answers
103
Closing Remarks
Peter GainesPartner, Bell, Boyd & Lloyd LLC