Income Trusts Will Survive!

10/30/2007 12:00 am EST

Focus: GLOBAL

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

Gordon Pape, editor and publisher of the Income Investor, says Canadian royalty trusts will survive in some form, or they will be taken over at a premium by richer investors.

The income trust tax is now law. Unless something dramatic happens, it will come into effect on Jan. 1, 2011, exactly as announced by Finance Minister Jim Flaherty almost a year ago.

That brings us to the question of what happens after that. There is a general expectation that the trust sector will wind down over the next three years (the process has already started) and that by the time the new tax kicks in there will be very few of them left.

But more trusts than expected may survive.

"Canadians have proven they need and want high-yield securities," says Paul Bloom, who manages several closed-end funds for Citadel Investments. "Demographics are going to continue to drive that need."

[Meanwhile,] RBC Capital Markets published a research report that said in the past year, 48 trust takeout deals have occurred.

RBC's analysts found that the initial reaction to the news [of the end of tax exemption for the trusts] was a 21% drop in the S&P/TSX Capped Income Trust Index in the month immediately following. But between December and May the Index rebounded and recovered all of the November losses.

The pace of trust takeovers dropped off during the summer, due in large part to the credit crunch. But recently it has picked up again. So far, there have been six takeover offers in September and October at an average premium of 23%-in line with the premiums paid in earlier deals.

"We believe opportunities still exist for investors to benefit from this environment in the coming months," RBC writes. "Although 48 trust takeout deals and/or offers have occurred in the past 12 months, there are 215 trusts left remaining and 39 months until 2011,"

Some trusts have large tax pools that will protect part of all of their distributions as far out as 2015 or 2016. In some cases, they are implementing corporate reorganizations to take maximum advantage of this. Keyera Facilities Income Fund (OTC: KEYUF) is in this group.

Keyera is one of the few trusts Bloom is buying right now, along with two other TII recommendations: TransForce Income Fund (OTC: TIFUF) and Precision Drilling (NYSE: PDS). (Keyera last closed under $18, TransForce closed above $11 and Precision closed below $19-Editor.)

Obviously, the current situation is very fluid. We're in a transition stage that will take a couple of years to play out. But one thing appears certain: by the time 2011 rolls around, cash-hungry income investors may have many more choices than they expected.

The bottom line: don't give up on your trusts yet. If it's a quality operation, a take-out offer may be just months away. If that doesn't happen, the odds are the trust will either continue on, using tax pools, or convert to a high-yield corporation.

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