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Pengrowth deal breathes life into income trusts


DAVID PARKINSON
Wednesday, November 29, 2006

It was the kind of deal critics thought was no longer possible.

Pengrowth Energy Trust's $1.04-billion agreement to buy Canadian oil and gas assets from ConocoPhillips Co. does some key things that income trusts weren't supposed to be able to do in the aftermath of the federal government's decision to toughen tax rules for the sector. The deal will result in a substantial expansion of Pengrowth, despite indications that the government wants to limit growth of existing trusts. It also involves more than $1-billion in loans and a substantial issue of new trust units, evidence that the banks and the markets are still willing to take a chance on the trust sector, despite all the pessimism about the future of trusts that sent investors fleeing a few weeks ago. (The S&P/TSX energy trust index is still down 14 per cent from the day before the government dropped its bomb.)

Even though the government's new rules aren't to take effect on existing trusts for another four years, analysts had feared the pending changes would severely constrain access to capital and, by extension, stifle prospects for growth — which is considered critical for trusts if they are to maintain the cash distributions that form their key attraction for investors. But the Pengrowth deal suggests those growth fears could be overstated, at the very least.

“It seems to me that it's generally positive,” said portfolio manager Leslie Lundquist of Bissett Investment Management in Calgary, who manages more than $1-billion in income trust holdings for Franklin Templeton Investments. “It shows it's pretty much business as usual.”

In particular, trust experts Wednesday took heart in the implication that the government didn't stand in the way of the deal, which will increase Pengrowth's oil and gas production by 27 per cent and its reserves by 22 per cent.

“It suggests the government isn't going to do anything to stop the normal course of business of income trusts,” Ms. Lundquist said. “For the energy trusts, that means acquisitions.”

Federal Finance Minister Jim Flaherty said at the time of the announcement of the trust tax legislation that the government would permit “normal growth” of existing trusts, but would move to block “undue expansion.” Mr. Flaherty has yet to define “undue expansion,” but it has been widely rumoured that the government would cap new issues of trust units to finance acquisitions at 15 per cent of existing equity.

Pengrowth's deal certainly falls well within that rumoured cap, as the 20 million units it plans to issue to partially finance the purchase represent only 9 per cent of its current units outstanding. Even with an overallotment allowance, the maximum number of units it would issue would come to 10.5 per cent of its existing equity. The rest of the deal will be financed with a 12-month bank credit facility, and the company said it plans to raise up to $400-million from asset sales to help pay the balance of the purchase price.

The company acknowledged that it had received a “comfort letter” from the government, indicating it was comfortable with the proposed ConocoPhillips transaction — a letter that had come to light two weeks ago, although the identity of the companies involved hadn't been confirmed. In its news release Wednesday, Pengrowth suggested that the advanced state of its negotiations for the purchase — which included a $30-million “exclusivity fee” that the company would lose if the deal fell through — contributed to the government's decision to give its blessing to the acquisition. Other deals that haven't progressed as far as this one had might not be afforded the same treatment.

But, according to one analyst, word out of the Pengrowth deal is that the government won't place “hard and fast” limits on deal sizes or financings for acquisitions, so long as the size of transactions stay in the general range of those seen in the sector in recent years. That would take mergers on a grand scale off the table, but would still permit mid-sized acquisitions.

If true, that provides a ray of hope for a couple of pending energy trust takeovers: Shiningbank Energy Income Fund's planned acquisition of Rider Resources Ltd., which would result in about a 27-per-cent increase in Shiningbank's outstanding equity; and Crescent Point Energy Trust's proposed purchase of Mission Oil & Gas Inc., which would increase Crescent Point's outstanding units by 48 per cent.

However, it also would mean continued uncertainty for the trusts and their investment bankers, who won't know what size deals will be acceptable and what won't until the government comes out with firm rules.

On Wednesday, Mr. Flaherty said that he is working on setting out the rules for the income trust sector by Christmas. “We'll try to get the guidelines, the implementation rules, out by Christmas time,” said Mr. Flaherty.