What would you say if I told you there's an income-trust product in the Canadian market that offers similar yields to the old income-trust model, yet isn't subject to the federal government's crackdown that essentially put the income-trust sector out to pasture?
If you said "prove it," that would pretty much match the market's reaction so far.
Foreign-asset income trusts, or FAITs, are Canadian trusts that derive their cash flow from assets outside of Canada. The feds' October, 2006 announcement of new tax laws on the trust sector, which took effect Jan. 1, 2011, only applies to Canadian assets. Foreign assets are exempt, and always have been.
It took a while for the Canadian market to catch on to this, but Richard Clark – who gets the nod as the father of the FAIT – proved it could work when he successfully took Eagle Energy Trust public in a $150-million IPO in late 2010.
Yet more than a year after Eagle landed – and more than five years after the trust legislation was announced – FAITs still remain no more than a curiosity, little known to most investors. Only two FAITs (Eagle and Parallel Energy Trust) have successfully gone public. Two others filed preliminary prospectuses for initial public offerings, only to pull the plug on them.
This despite offering juicy yields (12.4 per cent on Parallel, 9.3 per cent on Eagle) to an investing public that is hungrier for income than it has been in decades. People are coming forward with products to sate that hunger – and they're batting a measly 2-for-4 trying to get them off the ground.
The blame, say people who have been working to get FAITs to market, lies somewhere between bad timing and bad precedents.
After several years of deteriorating markets, shrinking credit and financial panic, the IPO market was finally in recovery when Eagle launched its IPO in the fall of 2010 – and was looking even more rosy when Parallel raised nearly $400-million in April, 2011. That got the wheels turning in the FAIT market, with two more IPOs targeted for late last year.
Argent Energy Trust filed a preliminary prospectus in early August – just as the equity market slid into a pronounced, risk-averse slump. North American Oil Trust followed in November. But the Canadian IPO market had gone into hibernation; both offerings died.
While Argent sensed the mood and never actively marketed its proposed issue, North American Oil Trust did – and was wildly unsuccessful. (Word is they could only raise about one-tenth of the $375-million they were seeking.) That flop left a bad taste, and raised skepticism about the market's interest in FAITs.
And the performance of Parallel – which, due to its size, has been looked on as a "test case" for the FAIT model – has added fuel to those concerns. The trust cut its production forecast in January and announced a $47.6-million writedown on its reserves last month. Its trust units closed this week at $7.30 on the Toronto Stock Exchange, 27 per cent below the IPO price of $10.
With only a couple of FAITs successfully launched, and one of them making such costly missteps, the FAIT structure is suffering from a lack of "street cred," as one insider put it. The only thing that would really establish that credibility would be having more successful FAIT listings to serve as examples for investors.
FAIT proponents think the mood might be right for that to happen this year.
A recent $600-million financing from Crescent Point Energy Corp. – a former income trust that still boasts a trust-like dividend yield of nearly 7 per cent – was heavily oversubscribed, a sign that investors and underwriters may be rediscovering their appetite for energy issues with a strong yield component. Given that, several potential FAITs are believed to be preparing for launch. (Argent, for example, is believed to be looking to step back in the ring sometime this quarter, with an IPO north of $300-million.)
Before the end of 2012, we could have another half-dozen companies launching FAIT IPOs. If the majority of them work out, that could be the critical mass the FAIT segment needs to catch on with investors – opening the door for a product to fill the void left behind by the income trusts.
If they don't work out? Then we'll have to wonder whether FAITs are doomed to be another Betamax – a great idea that no one would buy.