The Growth of Income Trusts in Canada
and the Economic Consequences
Vijay Jog and Liping Wang*
ABSTRACT
Income trusts do not necessarily represent a one-time financing vehicle for mature
companies with free cash flow and no growth prospects. Amounts raised through
income trusts are used not only for the acquisition of interests in operating companies
or underlying assets, but also for the refinancing of existing debt and for new capital
expenditures or acquisitions. The authors argue that income trusts may represent a
new method of market discipline whereby managers are obliged to distribute free cash
flow and are required to go to capital markets for the financing of new opportunities,
thus reducing potential agency costs associated with the monitoring of managerial
decisions. The authors show that income trust initial public offerings display a low degree
of underpricing (as expected) and an extremely small degree of immediate aftermarket
volatility, and that their stock market performance during the 2000-2003 period was
superior to the performance of the TSX 300 index. This indicates that, from a risk-return
perspective, income trusts have been a welcome addition to Canadian investors’
portfolios. The authors also offer some indirect and preliminary observations that may
have implications for estimates of the impact of income trusts on tax revenues.
KEYWORDS: INCOME TRUSTS ■ IPO ■ INVESTING ■ FINANCING
CONTENTS
Introduction
Background
Reasons for the Emergence and Growth of Income Trusts
Theoretical Foundations
Capital Market Conditions
Summary
The Growth of Income Trusts: Evidence and Supporting Data
Sources of Data
854
854
858
858
860
861
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862
* Vijay Jog is a Chancellor Professor at the Sprott School of Business, Carleton University,
Ottawa; Liping Wang is a consultant at Corporate Renaissance Group, Ottawa. The opinions
expressed in this paper are those of the authors alone. The authors thank Chunmei Hu and
Phil Zu for providing expert research assistance and Michael King and Gilbert Menard for
comments and suggestions.
(2004) vol. 52, n o 3
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canadian tax journal / revue fiscale canadienne
Results of Analysis
Summary
Uses of Proceeds
Underpricing and Post-Issue Performance
Conclusion
(2004) vol. 52, n o 3
862
868
870
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878
INTRODUCTION
Income trusts first became popular in the pre-dotcom era; interest in income trusts
revived in the post-2001 period as investors began to see income trusts as an
attractive way to raise capital in a somewhat moribund initial public offering (IPO)
environment. In Canada, income trusts dominated the IPO market during the
2002-2003 period; there has been almost no other IPO activity.1
The rapid growth of the income trust market has raised many questions about
the impact of income trusts on present and future economic growth, corporate
governance and disclosure, tax revenue,2 and risk-return tradeoffs. In this paper, we
focus on three specific aspects of income trusts. First, we describe the growth of
income trusts, including IPOs and subsequent issuance. Second, we trace the uses
of proceeds from the investors to the ultimate use. Third, we focus on the income
trusts that chose the IPO route (as opposed to a conversion of common shares into
an income trust unit) and investigate underpricing and post-issue volatility and
performance to demonstrate the risk-return characteristics of these trusts. We also
comment on the implications of income trusts for capital markets and tax policy
parameters. We base our analysis on a carefully constructed information set of the
income trust market in Canada as of August 2003.
In the next section we provide a brief background on income trusts. We then
suggest theoretical and capital market reasons that may explain their growth at this
particular time. Finally, we analyze and document our results for each of the three
principal focus areas, and offer our overall conclusions.
B A C KG R O U N D
Income trusts—including royalty trusts, business trusts, and real estate investment
trusts (REITs)—invest (usually through debt instruments) in operating companies
or assets; they receive their income through interest on debt; and they distribute
these receipts to the trust unitholders, usually as dividends (see figure 1). Given the
current state of the corporate and personal tax system in Canada, this structure
1 In 2002, we saw only 9 common stock IPOs with gross proceeds of $485 million, and as of
August 2003 there have been only 3 IPOs for $280 million. These numbers contrast to a total
94 IPOs of income trusts and gross proceeds of $7,780 million in 2002 and 2003. During the
same period, 14 public companies reorganized to income trust structures.
2 The tax-related issues are discussed in this policy forum by Lalit Aggarwal and Jack Mintz in
“Income Trusts and Shareholder Taxation: Getting It Right,” and by Tim Edgar in “The
Trouble with Income Trusts,” and are therefore not reviewed here.
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FIGURE 1 A Simplified Income Trust Transaction Structure
Unitholders
Units
Cash distributions (interest,
dividends, income from
property, return of capital)
Income trust
Distributable cash flow
(interest, dividends, net
profit interest)
Management
company
Debt /
common shares
Operating
company
Source: Raymond Jones, June 2003.
essentially allows for the creation of a transaction that resembles an indirect leveraged
buyout (LBO) transaction that is now available to individual investors through the
purchase of income trust units.
The organizational structure shown in figure 1, even with the additional layer
of costs associated with the management of the income trust, has the potential to
minimize (optimize) the total (corporate and personal) taxes paid to the government
without fundamental changes to the business economics. The capital structure of
the operating company could be transformed such that it pays out almost all of its
taxable earnings to the income trust as interest and brings its taxable income close to
zero. The income trust, in turn, distributes all that it receives to investors as dividends and, because it is essentially a flowthrough entity, accrues no tax payments.
Investors and entities, depending on their tax situation, either pay no taxes if they
hold these investments in a tax-deferred account such as a registered retirement
savings plan (RRSP) or in a pension fund, or pay taxes net of the dividend tax credit
at an effective tax rate that is lower than what they would have faced on the receipt
of interest income. If we ignore the changes in the financial riskiness of the operating
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company due to high leverage, the tax effect of the income trust is threefold: (1) it
promises a higher after-tax cash flow to taxable investors because of the less than
perfect integration of the corporate and personal tax regimes; (2) it provides a long
deferral if the units are held in tax-sheltered investment vehicles; and (3) it allows
for the almost complete elimination of corporate tax.
Because these types of organizational forms require that the underlying cash
flow stream be predictable and stable to minimize the risk of non-payment of
interest, they are not suitable for sectors in which there is considerable volatility in
the revenue and cost structure.3 When income trusts were originally introduced,
most of the trust securities were in the energy (pipelines) and real estate (mostly
commercial/industrial) sectors, where cash flows were fairly certain and the need
for reinvestment or growth opportunities was limited. In these sectors, one could
argue, the income trust structure makes business sense because the objective of the
management is to maximize shareholder wealth; one means of doing so is to create
a structure that minimizes the total taxes paid by a firm and its investors without
changing the firm’s fundamental risk characteristics. It should be noted that it is
not necessary that the income trust distribute the entire amount that it receives
from the operating company; if it does not, it is taxed on the undistributed amount.
Some trusts may hold back earnings as a cash reserve in order to stabilize distributions. Also, it is not necessarily the case that a volatile business cannot succeed as
an income trust; it will have a corresponding risk-return-pricing profile.
It is also important to understand the intricacies of the income trust financing
vehicles. As shown in figure 1, the operating company may be a private stand-alone
entity that decides to raise financing through an income trust vehicle for its entire
business (akin to a traditional IPO); it may be a private or publicly listed firm that
decides to carve out parts of its business into an income trust; or it may be a publicly
listed firm that decides to convert its common shares into income trust units without
any new financing at the time of conversion.
In the first two cases, the firm (the income trust) is required to file a prospectus
because it is essentially an IPO. In the case of conversion, the firm need only file a
plan of offering, which requires much less information; and, technically speaking,
it is not considered an IPO because there is no prospectus as such but simply a
reorganization by means of a conversion of one instrument (common shares) into
another (income trust units).
Moreover, in each case, there may be two distinct entities: (1) an income trust
that raises the capital and uses the proceeds to either acquire or invest in the
operating company, and (2) the operating company, which, after receiving the money
from the income trust, uses the proceeds to carry out either investment or financing
3 It is possible to use this structure in cyclical industries if the debtholders allow the corporation
to defer the interest payments. This can be achieved in a typical LBO structure by selling
“strips” where the interests of the debtholder and the shareholder are aligned and there is less
incentive for the debtholder to force bankruptcy in the event of non-payment of interest.
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decisions. These complexities require a careful analysis of the available data and
considerable work on “missing values.”
This new form of organizational structure raises many interesting questions
(leaving aside questions about the potential tax loss consequences). For example:
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Are income trusts likely to be an impediment to investment by the business
sector (because of the substantial distributions) and thus impair the potential
for productivity growth in Canada? More specifically, what is the empirical
evidence of the growth and the nature of income trusts? Is the money raised
through these arrangements channelled into productive investments? How
are the proceeds used by the underlying operating trust? Are income trusts
used mostly by firms as a way of securitizing or capitalizing an income stream
in situations where there is no need to reinvest in the maintenance of the
assets? Are organizations changing their investment behaviour because of
the availability and accessibility of income trusts?
What are the advantages and drawbacks of having an instrument that favours
greater distributions? How do income trusts trade off short-term versus
long-term benefits to maximize the wealth of unitholders and shareholders,
and what is the reasoning behind those decisions?
Are income trusts better suited for specific types of businesses? Is the traditional belief that income trusts are more suited to dominant enterprises in
mature sectors with little need for capital expenditures still valid? What tax
revenue implications arise from the recent emergence of income trusts that
are targeted to the carveouts of mature business units of a larger entity? Are
the characteristics of firms that use an income trust as a financing vehicle
changing significantly (as shown by the volatility of their revenue and earnings streams)?
What is the relationship between the pricing of income trusts and their postissuance volatility and performance? Does the pricing of the trust favour the
issuer, the investor, or the intermediaries? What are the costs of raising capital
through a trust rather than by means of a traditional IPO? What is the postissuance volatility of returns on income trusts? Do income trusts provide a
valid investment option from a diversification perspective?
How will income trusts be affected by an increase in interest rates and/or
stock prices? Can any causal relationship be hypothesized between interest
rates and the growth of income trusts?
Clearly, these are complex questions; we do not propose to answer them all in
this paper. We will focus on three principal aspects of income trusts.
First, we document as systematically as possible the growth in income trusts and
the changing nature of the income trust market in terms of the industrial composition of the firms that use this vehicle. This allows us to estimate the total size of the
income trust market. Second, we attempt to document the uses of proceeds by both
income trusts and underlying operating companies from the initial IPO financing
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and from subsequent issues. This allows us to evaluate the implications for economic
growth as well as the ultimate uses of proceeds. Third, we provide evidence of
under- and overpricing at the time of issuance, the immediate post-issue volatility,
and the long-term performance of income trusts. This allows us to comment on
the attractiveness of these new organizational forms from the investor’s perspective.4
REASONS FOR THE EMERGENCE AND
GROWTH OF INCOME TRUSTS
Theoretical Foundations
Three theoretical arguments are often cited to explain the emergence and growth
of the income trust.5 The first is based on the “free cash flow” concept arising from
agency theory literature; the second can be traced to the “bird in hand” principle
arising from dividend-policy literature, which focuses on asymmetric information
and the absence of costless arbitrage opportunities; and the third can be traced to
the optimal capital structure literature.6
The fundamental premise of the “free cash flow” argument is that in cases
where the free cash flow (defined as earnings after tax plus non-cash depreciation
and amortization minus sustaining capital expenditures and net additions to net
working capital) is very high, management may undertake capital expenditures or
acquisitions that are not value-creating. This behaviour occurs either because
management suffers from hubris or because management wants to increase the size
of the firm and its own (often size-based) compensation. One way of preventing
this behaviour is to require management to distribute the free cash flow to investors in the form of dividends and to go to the capital market to raise money for new
capital expenditures or acquisitions. This way, management must convince shareholders that the new financing will lead to a value-creating result. This will impose
capital market discipline on managerial decisions, with a corresponding decrease in
agency costs. Thus, the high distribution of free cash flow (often referred to as
distributable cash flow in income trust arrangements) can be viewed as consistent
with the “free cash flow” argument and can partially explain the emergence and
growth of income trusts.
4 In this paper, we do not conduct any specific statistical tests of any specific hypotheses. We
believe that the available data, the period under consideration, and the interaction of many
potential variables make it impossible to construct and test for a specific set of hypotheses.
5 There is a vast amount of literature in these two areas; for the sake of brevity, we refer only to
the most relevant papers.
6 See Michael C. Jensen, “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers”
(1986) vol. 76, no. 2 The American Economic Review 323-29, for the “free cash flow” argument,
and Merton H. Miller and Franco Modigliani, “Dividend Policy, Growth and the Valuation of
Shares” (1961) vol. 34, no. 4 Journal of Business 411-33 and Sudipto Bhattacharya, “Imperfect
Information, Dividend Policy, and ‘the Bird in the Hand’ Fallacy” (1979) vol. 10, no. 1 Bell
Journal of Economics 259-70, for the “bird in hand” argument.
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The “bird in hand” argument follows a similar chain of reasoning without necessarily resorting to formal agency theory. Under this hypothesis, which is based on
the notion of imperfect or asymmetric information, investors prefer to receive
higher dividends (and be subject to taxes) than wait for uncertain capital gains.
However, it should also be noted that the US evidence indicates that, in recent
years, cash dividends to shareholders have actually started to diminish at an alarming
rate, while share repurchase activities have continued to grow.7 Thus, firms have
chosen a more tax-preferred vehicle to distribute free cash flow; the underlying
argument remains unchanged.
Although the two arguments described above deal with the distribution of free
cash flow to prevent managers from undertaking “bad” investments, management
does not have to resort to an income trust arrangement to distribute excess cash flow.
It can simply pay out a substantial amount of free cash flow through dividends.
Beginning with Modigliani and Miller,8 Myers,9 and Miller,10 the implications of
the tax shield on interest payments for firm valuation has fascinated financial
economists. The argument, in its most simplistic form, is that, in the absence of
bankruptcy costs and with perfect conditions for individual tax arbitrage, significant value can be gained by considerably leveraging the firm’s capital structure.
This value can be further enhanced by tailoring the financing on the basis of the
taxable status of the investor or the tax attributes of the savings vehicle to be used
by the investor.
Briefly, if the firm was considered to always have an “earnings before income tax”
stream higher than interest expense, and if the recipient of that interest income
paid no taxes (or could defer taxes for a long time) on the receipt of that income, a
highly leveraged capital structure would enhance the value of the firm at the
expense of the government’s tax receipts. In this simple world, firms would be
highly leveraged and the debt instruments would be held by tax-exempt institutions such as pension funds or by individuals in their tax-exempt portfolios (such as
RRSPs). The exact nature of the gain through this leverage would depend on the
relative levels of the corporate tax rate, the tax rate on dividends and capital gains,
7 See Eugene F. Fama and Kenneth R. French, “Disappearing Dividends: Changing Firm
Characteristics or Lower Propensity To Pay?” (2001) vol. 60, no. 1 Journal of Financial
Economics 3-43; Eugene F. Fama and Kenneth R. French, “Testing Trade-Off and Pecking
Order Predictions About Dividend and Debt” (2002) vol. 15, no. 1 The Review of Financial
Studies 1-33; and Gustavo Grullon and Roni Michaely, “Dividends, Share Repurchases and the
Substitution Hypothesis” (2002) vol. 57, no. 4 The Journal of Finance 1649-84.
8 Franco Modigliani and Merton H. Miller, “The Cost of Capital, Corporation Finance and the
Theory of Investment” (1958) vol. 48, no. 3 The American Economic Review 261-97, and Franco
Modigliani and Merton H. Miller, “Corporate Income Taxes and the Cost of Capital: A
Correction” (1963) vol. 53, no. 3 The American Economic Review 433-43.
9 Stewart C. Myers, “Determinants of Corporate Borrowing” (1977) vol. 5, no. 2 Journal of
Financial Economics 147-76.
10 Merton H. Miller, “Debt and Taxes” (1977) vol. 32, no. 2 The Journal of Finance 261-75.
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and the tax rate on interest.11 If the effective tax rate on interest income was zero,
then the value of the leverage would equal the tax shield on debt and would
increase the value of the firm by a corresponding amount. If the corporate tax rate
was higher than the effective dividend tax rate, there would be a value gain for the
firm, and both parties could benefit.12 This arrangement could be achieved through
an LBO as well as through the creation of an income trust.
Thus, if a transaction or agreement can be structured to maximize the value of
the tax shield on debt, it will be an attractive investment for both the firm and the
investor. As long as these transactions respect the prescribed tax rules, it is left to
the capital market participants to innovate structures that optimize the overall taxminimization structures; one of these is the income trust, which allows the individual
investor to participate in these potentially tax-optimizing transactions.
Capital Market Conditions
There are (at least) three other reasons for the emergence and the recent growth of
income trusts.13 First, the growth in income trust-type arrangements is a result of
individual investors’ reactions to low interest rates and the attractiveness of taxpreferred, certain, high dividend streams promised by income trusts. Second, many
investors have become skeptical of management intentions because of recent incidents of weak or non-existent corporate governance; they prefer high dividend
distributions from firms so as to minimize value-destroying management behaviour. This is especially relevant for firms that do not have any significant growth
opportunities in their business but have a steady stream of free cash flow. Third,
given lower valuation levels during the post-dotcom era and the perceived reluctance of investors to invest in traditional IPOs, the only way left for corporations
that either are mature or have business units that are mature to raise capital at
favourable prices is to resort to an income trust arrangement.14 The recent capital
11 The gain from leverage in an integrated tax world equals (1 - [(1 - Tc ) * (1 - Tps )/(1 - Tpb)] * B
where Tc is the corporate tax rate, Tps is the tax rate on income received from holding shares,
Tpb is the tax rate on interest received on debt, and B is the value of debt.
12 Without going into detail, we assume that the investors are converting the capital structure from
low or no leverage to high leverage. There could be additional gains if the firm is acquired with
a higher value than the asset value and the difference is used to write up the assets. The gain
results from the higher tax shield on depreciation on the written-up value of the asset base.
13 For a broader description of issues that also span corporate governance and legal and
regulatory matters, see Michael R. King, Income Trusts—Understanding the Issues, Working
Paper 2003-25 (Ottawa: Bank of Canada, September 2003).
14 An alternative way of achieving similar goals is to distribute free cash flow from the stand-alone
or mature business units through special dividends or through share purchase. The US evidence
indicates that there has been a noticeable decrease in special dividends as a primary method of
distributing free cash flow but an increase in share purchase. See the evidence provided by
Harry DeAngelo, Linda DeAngelo, and Douglas J. Skinner, “Special Dividends and the Evolution
of Dividend Signaling” (2000) vol. 57, no. 3 Journal of Financial Economics 309-54, and their
the growth of income trusts in canada and the economic consequences
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market conditions provide partial support for this explanation. According to Standard & Poor’s Canada,15 in 2002 corporate debt issuance fell to a six-year low, with
issuance volumes running at about half the total borrowings of Cdn $89.4 billion in
2001—a record low for the Canadian corporate bond market. Common equity
financings were also at their lowest point in almost a decade, and issuance volumes
were at half their record levels of Cdn $26.5 billion in 1997. In this type of environment, the choices for financing may be limited to bank financing, private equity, or
alternative forms of raising capital. Income trusts may have provided that alternative form.
Summary
On a theoretical and practical basis, the emergence and growth of income trusts is
due to the combination of the three factors set out above rather than to a single
driving factor; all three factors are equally important in explaining the growth of
the income trust market. Although income trusts were initiated in the energy and
real estate sectors in the early period, the familiarity of investors and the investment community with income trust arrangements has now led to the use of income
trusts in other sectors and situations. In addition, some companies that went
private or were bought out in an LBO transaction as recently as 2000 are going to
the marketplace and raising capital (to essentially provide returns to original investors) through the use of income trusts. The popularity of these instruments is such
that some US-based companies are known to be looking at income trusts as a
primary source of capital and a means to monetize their investment in specific
parts of their business lines.16
THE GROWTH OF INCOME TRUSTS:
E V I D E N C E A N D S U P P O R T I N G D A TA
In this section, we provide evidence of the growth of income trusts and the nature
of the income trust market. However, it should be noted that there are significant
limitations in obtaining all necessary historical data on every income trust in Canada.
As a result, the number of income trusts in each table varies. In some cases, the
relevant data are not provided by the firm in its prospectus, press release, or documents
explanation that special dividends are now ineffective as a signalling method and that the share
purchase may be a better signal that also has preferential tax attributes over dividends.
15 S & P Research on Stability Ratings, “Income Trusts: Canada’s High-Yield Market?” by Maria
Rabiasz, John R. Tysall, and Thomas G. Connell, published on January 7, 2003 (http://
www2.standardandpoors.com/NASApp/cs/ContentServer?pagename=sp/sp_article/
ArticleCollectionTemplate&cid=1036172174951).
16 In the United States, such arrangements are difficult to achieve under the existing tax policy
regime. The United States has both “substance over form” and earnings-stripping rules that
also specify the “appropriate debt-equity” ratios to qualify for interest deductions. For a brief
description of how these rules apply for cross-border transactions, see Lalit Aggarwal and Jack
Mintz, “Income Trusts and Shareholder Taxation: Getting It Right,” in this policy forum.
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submitted to the Ontario Securities Commission. We have taken all possible care
in collecting the data, and we will explain the limitations and the implications of
the incomplete data with respect to our observations and conclusions.
Sources of Data
Our data come from multiple sources; no single source of data covers all aspects of
income trusts. Our main data sources include the Toronto Stock Exchange Monthly
Review, Investcom (http://www.investcom.com/), Stock Guide (published by Stock
Guide Publications Inc.), SEDAR (http://www.sedar.com/), and the Canadian Financial Markets Research Centre (CFMRC). We used the Monthly Review to ensure
that we have identified all the income trusts that were listed on the Toronto Stock
Exchange as of August 2003;17 we validated this list with Investcom wherever possible. Our main source of data for prospectuses is SEDAR, which stores in electronic
form all the prospectuses of IPOs starting from 1997. We use Stock Guide to obtain
accounting data and to cross-validate the Toronto Stock Exchange listings. Finally,
we use the CFMRC database to obtain stock price, dividend, and returns data for the
listed IPOs. We have identified 255 income trusts that were listed on the Toronto
Stock Exchange as of August 2003.
Results of Analysis
Table 1 summarizes the 255 income trusts in our sample; they are categorized by
their industry sectors and their year of listing on the Toronto Stock Exchange.
Investment trusts are defined as those that invest in other income trusts and act as
mutual funds in the sense that they do not invest directly in operating companies.
We classify the rest of the income trusts in four categories: REITs, business trusts,
resource trusts, and utility trusts. We split our sample into pre-1997 and post-1997
periods, because we have more information about the post-1997 sample owing to the
establishment of SEDAR in 1997.
As can be seen from the results in table 1 (ignoring the category of investment
trusts, since these invest in other income trusts), the largest number of income trust
IPOs were issued in 2002, surpassing the previous high of 31 in 1997. Moreover, of
the 43 IPOs issued in 2002, the largest number is represented by business trusts,
showing the acceptance by the market of these types of securities. In addition, the
existence of 104 investment trusts signifies the popularity of intermediaries that
have emerged to provide opportunities for investing in a potentially diversified
portfolio of income trusts. It should be noted that the income trust market was fairly
dormant from 1998 to 2000, when stock markets were providing extra-normal
returns to investors, indicating that the growth of income trusts is at least partially
related to the capital market environment.
17 We are investigating whether there have been some delistings during the intervening years.
Our preliminary findings are that there are very few delistings of income trusts.
the growth of income trusts in canada and the economic consequences
TABLE 1
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863
Number of Income Trust IPOs as at August 2003
Post-1997
Category
Investment . . . . .
REIT . . . . . . . . .
Business . . . . . . .
Resource . . . . . . .
Utility . . . . . . . . .
Unknown* . . . . .
Total . . . . . . . . . .
Pre-1997 1997 1998 1999 2000 2001 2002 2003 Unknown* Total
10
6
2
18
2
4
42
20
8
11
5
7
0
51
4
2
1
1
1
0
9
8
1
1
0
1
0
11
5
0
0
0
0
0
5
14
3
4
4
1
0
26
21
5
26
8
4
0
64
15
2
8
7
4
0
36
7
3
0
0
0
1
11
104
30
53
43
20
5
255
* We were not able to classify these funds either by category or by the year of issuance.
Table 2 provides a further breakdown of income trusts in the business, resources,
and utilities sectors by industry category. As can be seen, the business sector is
dominated by consumer and food services companies, the resources sector is dominated by oil and gas, and the utilities sector is dominated by power generation.
Of the 255 income trusts listed on the Toronto Stock Exchange, we were able to
collect 145 prospectuses for income trust IPOs. We investigated an additional 57
income trusts in the business, resources, and utilities sectors for which prospectuses
are not available in the SEDAR database. Of these, 36 were formed through IPOs.
The remaining 21 income trusts, including 8 business trusts and 13 resources trusts,
represent conversions from previous corporate forms into income trusts pursuant
to “plans of arrangement.” For these conversions, there was no requirement that
prospectuses be filed. Of the 21 restructurings, 18 occurred in the 2001-2003
period, including 7 in the 2003 year to date.18 Table 3 lists the number of prospectuses in our sample.
In addition to the 145 income trusts for which we have prospectuses, we were
able to collect data on issue proceeds for an additional 50 income trusts from the
“Newly Listed Companies” section of the Monthly Review even though we had no
prospectuses for them (see table 4). As a result, we have proceeds data on a total of
195 income trusts, of which 171 were issued in the post-1997 period compared
with the universe of 213 (see table 1). Twenty income trusts have resulted from
restructurings in the post-1997 period (one was restructured in 1988); they represent companies that simply converted their common shares into income trust units
and did not raise any new financing. Thus, in the post-1997 period, we are missing
proceeds data for only 22 income trusts.
We are also interested in understanding the post-issuance financing behaviour
of income trusts because it has implications for economic growth; therefore, we
18 Of the 21 conversions, 1 (NewAlta income fund) took place in 1988, 2 in 1997, 4 in 2001, 7 in
2002, and 7 in 2003 (as of August 2003). The total market value of the 18 conversions for
which we have data was $5.2 billion based on market capitalization on the year-end before the
conversion year. The market value of the 17 trust funds for which we have data as of
November 28, 2003 was $8.5 billion.
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TABLE 2
(2004) vol. 52, n o 3
Number of Income Trusts by Industry Sectors
Business
Cheque design . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Communications/media . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Consumer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Food service . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Forest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Industrial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Transportation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Wastage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unknown* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1
3
12
9
1
9
7
1
10
Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
53
Resources
Gas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Oil and gas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Oil and gas services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Power generation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unknown* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2
1
24
4
1
11
Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
43
Utilities
Pipeline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Power generation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Telecommunication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unknown* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5
11
2
2
Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
116
* We were not able to classify these funds in unique subsector categories. Since all REITs are in
the real estate sector, we have not classified them in subsectors within the real estate sector.
collected 101 prospectuses for subsequent unit issuances by 41 income trusts (see
table 5).
Using the information gathered from these various sources, we estimate that
total income trust financing amounts to $36 billion, including $27 billion for the
195 IPOs and about $8.5 billion for 101 subsequent issuances by 41 income trusts
(see table 6). However, these numbers include financing by investment trusts, which
constitutes indirect financing. Thus, for the remainder of the paper, we exclude all
references to investment trusts.
Tables 7 and 8 exclude financing by investment trusts to eliminate the double
counting; the proceeds are $19.51 billion for IPOs and $7.52 billion for subsequent
issues—a total of about $27 billion.
Several observations follow from these results. First, 1997 is the year in which
most financing through income trusts took place. Second, in 2000 (at the peak of
the dotcom bubble) there were no financings through income trusts because the
technology sector and the overall stock market provided investors with ample
the growth of income trusts in canada and the economic consequences
TABLE 3
■
865
Number of Income Trusts for Which IPO Prospectuses Are Available
Post-1997
Category
Pre-1997 1997
Investment . . . .
REIT . . . . . . . .
Business . . . . . .
Resource . . . . . .
Utility . . . . . . . .
Total . . . . . . . . .
TABLE 4
0
0
0
0
0
0
1998
1999
2000
2001
2002
2003
Total
3
2
1
1
0
7
6
1
1
0
1
9
5
0
0
0
0
5
14
3
3
1
1
22
21
5
22
3
4
55
14
2
7
2
4
29
67
19
37
9
13
145
Total
4
6
3
2
3
18
Income Trusts with IPO Proceeds Available
Post-1997
Category
Pre-1997 1997
Investment . . . .
REIT . . . . . . . .
Business . . . . . .
Resource . . . . . .
Utility . . . . . . . .
Total . . . . . . . . .
TABLE 5
6
1
1
15
1
24
1998
1999
2000
2001
2002
2003
4
2
1
1
1
9
6
1
1
0
1
9
5
0
0
0
0
5
14
3
3
1
1
22
21
5
23
3
4
56
14
2
7
2
4
29
16
6
9
4
6
41
Subsequent Issuances
Post-1997
Category
Pre-1997 1997
Investment . . . . .
REIT . . . . . . . . .
Business . . . . . . .
Resource . . . . . . .
Utility . . . . . . . . .
Total . . . . . . . . . .
TABLE 6
86
20
45
26
18
195
0
0
0
0
0
0
1
3
1
5
1998
1999
2000
3
1
3
2
1
1
6
4
13
1
4
5
2001
2002
4
1
11
5
21
2
3
5
11
3
24
Total no.
2003 of issuances
2
2
8
12
5
29
7
16
15
44
19
101
No. of
income
trusts
5
4
9
15
8
41
Total Trust Financing ($ Millions)
Category
Investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
REIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Resource . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Utility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
IPO
Subsequent
Total
7,790.75
7,186.20
2,753.06
5,691.56
3,881.40
27,302.98
1,034.88
1,607.97
680.16
3,359.44
1,871.11
8,553.56
8,825.64
8,794.17
3,433.21
9,051.00
5,752.51
35,856.53
866
■
(2004) vol. 52, n o 3
canadian tax journal / revue fiscale canadienne
TABLE 7
Income Trust IPOs: Gross Proceeds Excluding
Investment Trusts ($ Millions)
Post-1997
Category
Pre-1997
1997
REIT . . . . . .
Business . . . .
Resource . . . .
Utility . . . . . .
Total gross
proceeds . . .
157.00
250.19
3,208.23
81.50
817.77
1,835.43
1,409.03
1,782.04
3,696.93
5,844.27
TABLE 8
1998
1999
Gross
proceeds
2000
2001
2002
2003
341.70
24.00
87.25
9.00
41.50
—
296.00 141.87
—
—
—
—
505.00
446.75
187.91
110.00
679.51
2,742.55
669.75
939.40
228.07
1,815.02
175.13
530.60
766.45
—
1,249.66
5,031.21
2,748.82 19,512.22
2003
174.87
2,753.06
7,186.20
5,691.56
3,881.40
Subsequent Issues: Gross Proceeds Excluding
Investment Trusts ($ Millions)
Category
1997
1998
1999
REIT . . . . . . .
Business . . . . .
Resource . . . . .
Utility . . . . . . .
Total gross
proceeds . . .
—
252.24
543.10
68.00
85.40 100.08
—
—
—
31.60
64.53
—
863.34
149.93 131.68
Gross
proceeds
2000
2001
2002
35.50
—
292.80
167.79
172.05
100.00
652.34
434.44
188.02
99.12
680.16
547.68
708.06 1,607.97
790.58 1,049.02 3,359.44
536.76
599.58 1,871.11
496.09 1,358.83 2,063.05 2,455.77 7,518.68
opportunity to invest. Third, income trusts in the business sector now represent a
significant fraction of total IPO financings. Fourth, the $9 billion in income trust
financing from 2001 to August 2003 now equals all financings before 2000. These
results indicate that income trusts have become a significant source of financing for
the Canadian corporate sector.19
In addition to first-time financing, there was also significant activity in the secondary issuance by income trusts, as shown in table 7. Here again, 2002 stands out.
Including the $2 billion raised through subsequent issuance, the total capital (IPO
and subsequent issues of previous-year IPOs) that flew into income trusts amounted
to $2.7 billion in 2001, $7 billion in 2002, and $5.2 billion in the first eight months
of 2003.
From table 8, it is apparent that there is considerable activity in subsequent
issuances of trust units. To better understand the source of this activity, we investigated the prospectuses available to us. Table 9 shows the results of this investigation
for both IPOs and subsequent financing issues.
19 As noted earlier, in 2002, corporate debt issuance fell to a six-year low, with issuance volumes
running at about half of total borrowings of Cdn $89.4 billion in 2001—a record low for the
Canadian corporate bond market. Common equity financings were also at their lowest point in
almost a decade, and issuance volumes were cut in half compared with record levels of
Cdn $26.5 billion in 1997.
No.
37
9
13
59
Business . . . . . . . . . .
Resources . . . . . . . . .
Utilities . . . . . . . . . .
Total . . . . . . . . . . . . .
5,146.86
2,085.30
2,801.44
10,033.60
$ mil.
Prospectus available
8
17
5
30
No.
2,039.34
3,606.26
1,079.97
6,725.57
$ mil.
Prospectus unavailable,
proceeds available
IPOs
Financing Through IPOs and Subsequent Issues
Category
TABLE 9
45
26
18
89
No.
7,186.20
5,691.56
3,881.41
16,759.17
$ mil.
Subtotal
9
15
8
32
Trusts,
no.
15
44
19
78
Issuances,
no.
Subsequent issues
1,607.97
3,359.44
1,871.11
6,838.52
$ mil.
8,794.17
9,051.00
5,752.52
23,597.69
Total
proceeds,
$ mil.
the growth of income trusts in canada and the economic consequences
■
867
868
■
canadian tax journal / revue fiscale canadienne
(2004) vol. 52, n o 3
Our sample represents 87 percent of the total proceeds; most of the 24 trusts
with missing prospectuses were issued before or in 1997.20 The numbers in table 9
indicate that resource sector income trusts frequently go to capital markets for
financing through subsequent issuance; 15 of the 26 issuers raised an additional
$3.4 billion in subsequent financing compared with $5.7 billion in IPOs. Utility
sector issuers raised almost 50 percent of the IPO amount through subsequent
issuances; for the business sector, subsequent issues represent 22 percent of financing. Overall, subsequent issues amount to 41 percent of the IPO financing.
It is also interesting to analyze the amount of financing in subsequent years in
relation to the initial financing year, as well as the number of issuances and the number
of income trusts that go to the market for financing. Table 10 shows the amount of
proceeds of subsequent financing in relation to the initial financing amounts raised
through IPOs. Some of the trusts go to capital markets for additional funding in the
first year (almost immediately) after the IPO, but (based on IPOs in 1996 through
1999) they also raise financing in years 3 through 5. Comparing the two periods of
1996-1997 and 2002-2003, we see that the elapsed time between the IPO and
subsequent issues, and between subsequent issues, has decreased significantly. We
investigate the uses of these proceeds in the next section.
In terms of the number of issues and issuers associated with these amounts,
table 11 shows that income trusts that went public in 1996 and 1997 and as recently
as 2001 and 2002 are the source of most of the subsequent issues. Table 11 also shows
the relationship between the total number of instances and the underlying number
of income trusts that represent these instances. Although there are 54 known
instances of secondary issuance, they are represented by only 24 of the 96 income
trusts. To further investigate this observation, we identify these frequent issuers in
table 12, which shows that 12 income trusts that returned to market most frequently
accounted for two-thirds of the total instances. This is an interesting result, since
the main purpose of income trusts was (presumed to be) to invest in mature, nogrowth operating companies that required no additional capital. However, nearly
60 percent of the proceeds from subsequent issuances were used to fund capital
expenditures or new acquisitions, or to repay bridging loans for recent acquisitions.
This distribution is similar for frequent issuers and for one-off issuances (see the
following section, “Uses of Proceeds,” for more details).
Summary
Four principal conclusions follow from the data presented in this section. First,
almost $35 billion has been invested in income trusts (ignoring investment in those
companies that have converted from common shares to income trust units), with
almost one-third of that amount represented by investment trusts. Second, there
20 The $23.5 billion figure represents 87 percent of the total of IPO financing ($19.5 billion from
table 6) and $7.5 billion of subsequent financing (table 7).
the growth of income trusts in canada and the economic consequences
TABLE 10
IPO year
1996 . . . . . . .
1997 . . . . . . .
1998 . . . . . . .
1999 . . . . . . .
2000 . . . . . . .
2001 . . . . . . .
2002 . . . . . . .
2003 . . . . . . .
Unknown . . .
Total . . . . . . .
■
869
Proceeds of Subsequent Issues Versus IPO Issuance
Year Proceeds ($ Millions)
IPO
proceeds
Proceeds of subsequent issues by issue year
1997
1998
1999
2000
2001
2002
2003
2,804.93 320.16
4,019.22 543.18
128.75
na
150.87
na
na
2,694.66
na
4,351.70
na
2,520.75
na
—
64.53
—
na
na
na
na
na
31.60
—
—
—
na
na
na
na
16,670.88 863.34
64.53
31.60
128.97 183.70
96.40 601.53
105.45 293.01 415.96 332.13
28.48
17.50
—
—
25.45 141.43 205.80
—
—
—
—
—
na
65.05 555.05 118.44
na
na
22.50 638.32
na
na
na
55.03
172.24 486.09 579.31 611.21
460.59 1,186.78 1,875.03 2,356.65
Total
1,362.37
1,754.25
45.98
372.69
—
738.54
660.82
55.03
1,848.85
6,838.52
na Not applicable.
TABLE 11
Number of Subsequent Issues by Year Versus IPO Year
of the Issuing Trusts
IPO year
1996 . . . . . . . . . .
1997 . . . . . . . . . .
1998 . . . . . . . . . .
1999 . . . . . . . . . .
2000 . . . . . . . . . .
2001 . . . . . . . . . .
2002 . . . . . . . . . .
2003 . . . . . . . . . .
Unknown . . . . . .
Total . . . . . . . . . .
No. of
IPOs
Subsequent issues by year
Total Issuing
1997 1998 1999 2000 2001 2002 2003 instances trusts
15
18
3
2
1
10
33
14
2
3
na
na
na
na
na
na
0
1
0
na
na
na
na
na
1
0
0
0
na
na
na
na
96
5
1
1
3
2
1
1
0
na
na
na
3
10
3
4
1
1
0
2
na
na
6
17
1
3
0
1
0
5
1
na
8
19
4
4
0
0
0
2
7
1
7
25
14
17
2
3
0
9
8
1
24
78
3
6
1
1
0
4
8
1
7
na
na Not applicable.
has been an increase in the number and the diversity of firms that use income trusts
rather than the traditional IPO to seek financing. Almost $9 billion has been raised
by business sector income trusts; this amount is nearly equal to that raised by
resource sector companies. Third, the income trust market has been cyclical.
During the period from 1998 through 2000, when the equity market was rising,
the use of income trusts was almost negligible. There were no income trust IPOs in
2000, when equity markets were high. But a record number of IPOs were issued in
2002, when equity market valuations were low, traditional IPOs were almost nonexistent, and the economy was characterized by low interest rates. Fourth, subsequent
financing represents almost 40 percent of the initial financing through IPOs. In fact,
this amount is understated: a large number of companies raised IPO financing in
2002, and it may be too early for them to seek subsequent financing. The evidence
870
■
canadian tax journal / revue fiscale canadienne
TABLE 12
(2004) vol. 52, n o 3
Frequent Subsequent Issuers
Company
ARC Energy Trust . . . . . . . . . . . . . . . . . . . . . .
Algonquin Power Income Fund . . . . . . . . . . . .
Pengrowth Energy Trust . . . . . . . . . . . . . . . . .
Enerplus Resources Fund . . . . . . . . . . . . . . . . .
Superior Plus Income Fund . . . . . . . . . . . . . . .
Ultima Energy Trust . . . . . . . . . . . . . . . . . . . . .
Acclaim Energy Trust . . . . . . . . . . . . . . . . . . . .
Advantage Energy Income Fund . . . . . . . . . . .
Great Lakes Hydro Income Fund . . . . . . . . . .
Inter Pipeline Fund . . . . . . . . . . . . . . . . . . . . . .
Provident Energy Trust . . . . . . . . . . . . . . . . . .
Rogers Sugar Income Fund . . . . . . . . . . . . . . .
All others . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ticker
Category
AET.UN
APF.UN
PGF.UN
ERF.UN
SPF.UN
UET.UN
AU.UN
AVN.UN
GLH.UN
IPL.UN
PVE.UN
RSI.UN
Resource
Utility
Resource
Resource
Business
Resource
Resource
Resource
Utility
Utility
Resource
Business
No. of
subsequent
issues
8
6
6
5
4
4
3
3
3
3
3
3
27
78
suggests that income trusts have gone to capital markets to raise additional financing; in the next section, we will look at the specific uses of proceeds.
USES OF PROCEEDS
In this section, we investigate the uses of proceeds by income trusts. There are
three main reasons for this investigation. First, it provides us with information
about the efficacy of income trusts in contributing to economic growth. Second, it
allows us to determine whether the new financing is used mainly to maintain expected yields on the existing income trust units. Third, it may allow us to indirectly
investigate the tax revenue implications of the formation of income trusts.
To conduct this analysis, we examined 137 prospectuses—59 income trust IPOs
and 78 subsequent offerings issued by 32 income trusts. Table 13 shows the comparison of this sample to the total in the category. The 59 IPOs represent 60 percent of
the total IPO dollars, and the 78 subsequent issues represent 80 percent of total
subsequent financing. Resource trusts account for only 35 percent of the sector
because a large number of resource trusts in our sample were issued before 1997.
Table 14 summarizes the fees and costs associated with income trusts. On average,
for both IPOs and subsequent issuances, investment banking and other issuing
expenses together take up to 6 percent from the total proceeds. These results are
similar to those reported by Jog21 for traditional IPOs. On the basis of these numbers,
we estimate that the investment banking industry earned almost $800 million in
fees during the 2001-2003 period.
21 Vijay M. Jog, “The Climate for Canadian Initial Public Offerings,” in Paul J.N. Halpern, ed.,
Financing Growth in Canada (Calgary: University of Calgary Press, 1997), 357-401.
Proceeds, $ mil.
10,033.60
5,146.86
2,085.30
2,801.44
6,838.52
1,607.97
3,359.44
1,871.11
No.
59
37
9
13
78
15
44
19
IPO . . . . . . . . . . .
Business . . . . . . .
Resource . . . . . . .
Utility . . . . . . . . .
Subsequent . . . . . .
Business . . . . . . .
Resource . . . . . . .
Utility . . . . . . . . .
Prospectus examined
Uses of Proceeds: Analysis Sample
Category
TABLE 13
78
15
44
79
89
45
26
18
6,838.52
1,607.97
3,359.44
1,871.11
16,759.17
7,186.20
5,691.56
3,881.41
Proceeds, $ mil.
Total in same category
No.
100
66
82
35
72
% (no.)
100
60
72
37
72
% (proceeds)
101
255
No.
8,553.56
27,302.98
Proceeds, $ mil.
Total samples
the growth of income trusts in canada and the economic consequences
■
871
872
■
(2004) vol. 52, n o 3
canadian tax journal / revue fiscale canadienne
TABLE 14
Gross Proceeds Versus Net Proceeds Available
No. of
instances
Gross
proceeds
Investment
banking fees
59
78
10,033.60
6,838.52
546.51
318.97
Issuing
cost
Net
proceeds
$ millions
IPOs . . . . . . . . . . . . . . . . . . .
Subsequent issues . . . . . . . .
TABLE 15
155.30
37.18
9,331.79
6,482.37
Initial Public Offerings: Uses of Proceeds
Business
Use
Resource
Utility
Total
$ mil.
%
$ mil.
%
$ mil.
%
$ mil.
%
Acquisition of interest . . .
Acquisition of loan . . . . . .
Capital expenditures
and new acquisitions . . .
Repayment of
indebtedness . . . . . . . . .
Distribution to owners . . .
Other . . . . . . . . . . . . . . . .
Unknown* . . . . . . . . . . . .
4,286.47
81.00
90.3
1.7
1,620.70
29.00
82.8
1.5
2,255.69
41.36
85.8
1.6
8,162.86
151.36
87.5
1.6
29.30
0.6
38.18
2.0
119.25
4.5
186.73
2.0
284.36
28.28
7.58
28.96
6.0
0.6
0.2
0.6
53.40
209.13
4.80
2.01
2.7
10.7
0.2
0.1
4.00
168.52
39.26
0.55
0.2
6.4
1.5
0.0
341.76
405.93
51.64
31.52
3.7
4.3
0.6
0.3
Total . . . . . . . . . . . . . . . . .
4,745.96
100
1,957.20
100
2,628.63
100
9,331.79
100
* The prospectus does not specify the uses.
Next, we investigate the uses of proceeds as stated in the prospectuses of the
income trusts. Table 15 classifies the uses in seven categories.
Not surprisingly, $8.2 billion, or 87.5 percent, of IPO proceeds available to
income trusts was used to acquire the interest in the operating company. Although
the results are not shown here for reasons of space, income trusts in different
sectors displayed similar patterns.
The uses of proceeds in IPOs and in subsequent issuances are illustrated in
tables 16 and 17, respectively. In both cases, if the company (or the income trust)
specified that the proceeds were used to repay outstanding indebtedness incurred
to finance capital expenditures and acquisitions, we classified that amount as a
capital expenditure or acquisition because we considered debt a bridging loan.
Table 16 shows that of the $8.2 billion received by income trusts, 32.8 percent was
used to acquire assets and facilities and 27 percent was used to repay debt; the uses
of the remainder were not specifically outlined.
The uses of subsequent financing were quite different. Table 17 shows that
subsequent financing was principally used for capital expenditures and new acquisitions. Of the $6.5 billion in financing, $3.3 billion was used to finance capital
expenditures and new acquisitions; 23 percent ($1.5 billion) went to reduce indebtedness, followed by secondary offerings. This breakdown of uses suggests that new
financing may allow the underlying operating companies (or trusts) to monetize
the growth of income trusts in canada and the economic consequences
TABLE 16
■
873
Initial Public Offerings: Uses of Proceeds by
Operating Companies
Business
Use
Resource
Utility
Total
$ mil.
%
$ mil.
%
$ mil.
%
$ mil.
%
Acquisition . . . . . . . . . . . .
Repayment of debt . . . . . .
Other uses . . . . . . . . . . . . .
Unspecified . . . . . . . . . . . .
886.18
1,569.73
42.20
1,788.36
20.7
36.6
1.0
41.7
1,332.70
—
—
288.00
82.2
—
—
17.8
462.05
635.22
—
1,158.42
20.5
28.2
—
51.4
2,680.93
2,204.95
42.20
3,234.78
32.8
27.0
0.5
39.6
Total . . . . . . . . . . . . . . . . .
4,286.47
100
1,620.70
100
2,255.69
100
8,162.86
100
%
$ mil.
%
TABLE 17
Subsequent Issuances: Uses of Proceeds
Business
Use
$ mil.
Secondary offering . . . . . .
Capital expenditures
and new acquisitions . . .
Repayment of
indebtedness . . . . . . . . .
Other . . . . . . . . . . . . . . . .
Total . . . . . . . . . . . . . . . . .
Resource
Utility
Total
%
$ mil.
%
$ mil.
459.17
30.0
303.19
9.5
400.79
22.6
1,163.16
17.9
967.95
63.3
1,793.85
56.4
1,010.58
57.0
3,772.37
58.2
103.18
—
6.7
—
1,075.66
5.10
33.8
0.2
362.90
—
20.5
—
1,541.74
5.10
23.8
0.1
1,530.30
100
3,177.80
100
1,774.27
100
6,482.37
100
additional income-producing assets and to invest these proceeds in growth opportunities. For example, in the case of resource sector trusts, new financing permits the
companies to invest in new exploration; in the absence of an income trust arrangement and a robust equity market, they might have found it difficult to do so. It
should be noted that we have no proof that these investments are in fact valuecreating investments and that the capital market was indeed providing discipline
along the lines of the “free cash flow” argument mentioned earlier; all we can say is
that capital market participants provided additional capital to the existing income
trusts.22 We should also note that the prospectuses do not specify the reasons for a
surprisingly high percentage (39 percent) of capital raised; this omission may raise
the question whether the “market discipline” argument that results from the “free
cash flow” argument is relevant in explaining the growth of income trusts.
In summary, three broad conclusions can be drawn about the uses of proceeds.
First, and not surprisingly, an overwhelming fraction of money raised by income
trust IPOs went to the acquisition of interests in operating companies; the investment
22 We have no empirical evidence on “withdrawn” subsequent issues, if any. We are in the process
of collecting data on the price reaction on the announcement date of the subsequent issues to
see whether the reaction was positive (indicating potentially value-creating investments as
judged by the market participants) or negative.
874
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canadian tax journal / revue fiscale canadienne
(2004) vol. 52, n o 3
banking fees and issue costs amounted to between 5 and 7 percent. On the surface,
these fees seem high, since they are similar to the percentage fees for IPOs that are
riskier than income trusts. Second, the analysis of uses of funds by operating
companies arising from IPOs leads to the conclusion that, although the uses of
40 percent of funding are not described in the prospectuses, almost one-quarter goes
into replacement of the indebtedness; the other 40 percent goes into the acquisition
of interests, thereby triggering capital gains. Third, more than one-half (58 percent)
of the subsequent issuance amount goes into asset acquisition or capital expenditures, one-quarter goes into repayment of debt, and 18 percent pays for secondary
offerings of shares (presumably by existing shareholders). However, the uses of a
surprisingly large percentage of the amounts raised in subsequent offerings are not
specified in prospectuses, leading to some questions about the “market discipline”
argument explaining the growth of income trusts.
Projecting these numbers to the aggregate financing numbers from table 9
leads to the following estimated usage of the total $23.6 billion in financing raised
through IPOs and subsequent issues of income trusts. About $15 billion was used
by new income trust IPOs to acquire interests from operating companies, thereby
potentially triggering capital gains. Existing owner-investors sold almost $2 billion
through secondary offerings, which also results in potential capital gains. Another
$4.3 billion (mostly from subsequent issuances) was used to finance new acquisitions (triggering capital gains) or new capital expenditures. About $2.2 billion was
used to repay indebtedness, which represents the replacement of one source of
debt by another.
Although it is beyond the scope of this paper to investigate the tax revenue
implications of income trusts, our findings suggest that almost one-quarter of the
financings may have no implications for taxes and tax revenues, because they
replace existing indebtedness. Another 20 percent (assuming that the other half of
the 40 percent goes into new capital expenditures) of these financings also generate
capital gains taxes, because they are used to acquire ownership interests. The rest
may have implications for overall tax revenues.
UNDERPRICING AND POST-ISSUE
PERFORMANCE
In this section, we document the underpricing, aftermarket volatility, and longterm post-issue performance of income trust IPOs. This analysis provides us with
evidence on the efficiency of the market in pricing the issues and their risk-return
characteristics in the context of their attractiveness in the overall diversification of
investor portfolios.
It is well documented that, on average, IPOs are underpriced; that is, the firstday closing price is higher than the issue price after adjusting for the underlying
movements in the stock exchange index. For example, Ritter23 reports an average
23 Jay Ritter, “Initial Public Offerings” (1998) vol. 2, no. 1 Contemporary Finance Digest 5-30.
the growth of income trusts in canada and the economic consequences
■
875
15.8 percent underpricing (also referred to as initial return adjusted for the corresponding market return) among the more than 13,000 firms that went public in the
United States from 1960 to 1996. Jog and Wang24 provide Canadian evidence of
12 percent underpricing for a total 244 IPOs listed on the Toronto Stock Exchange
from 1990 to 1999. International evidence25 shows similar results.
A widely supported model developed by Rock26 to explain this observed underpricing assumes that information asymmetry exists between investors, who are
classified into two groups—informed and uninformed. Informed investors invest in
information production and subscribe to IPOs only when they believe that the IPOs are
underpriced. Uninformed investors are unable to distinguish underpriced IPOs from
overpriced IPOs and may subscribe equally to both. Consequently, underpriced IPOs
will be oversubscribed and are subject to quantity rationing. Uninformed investors
may eventually find that they are allocated more overpriced issues—in other words,
they are facing a “winner’s curse.” To keep uninformed investors in the IPO market,
issuers must set their issue price lower than the expected aftermarket price as
compensation to uninformed investors for their continuing participation. Beatty
and Ritter27 build on this asymmetric information model and argue that the higher
the ex ante uncertainty about the value of an issue, the more serious the information asymmetry problem; thus, more money is required to be “left on the table.”
Using aftermarket volatility as a proxy for ex ante uncertainty of IPO issues, many
researchers support the hypothesized positive relationship between ex ante uncertainty and expected underpricing.28
In contrast to the significant underpricing of common stock IPOs, some studies
have found that the initial return of income trust IPOs has been very low if not
statistically close to zero. In the United States, for example, a study of 55 IPOs of
24 Vijay Jog and Liping Wang, “Aftermarket Volatility and Underpricing of Canadian Initial
Public Offerings” (2002) vol. 19, no. 3 Canadian Journal of Administrative Sciences 231-48.
25 Tim Loughran, Jay R. Ritter, and Kristian Rydqvist, “Initial Public Offerings: International
Insights” (1994) vol. 2, nos. 2-3 Pacific-Basin Finance Journal 165-99; and Tim J. Jenkinson,
Alexander P. Ljungqvist, and William J. Wilhem Jr., “Bookbuilding Around the World”
(mimeograph, Oxford University and Boston College, 1999).
26 Kevin Rock, “Why New Issues Are Underpriced” (1986) vol. 15, nos. 1-2 Journal of Financial
Economics 187-212.
27 Randolph P. Beatty and Jay R. Ritter, “Investment Banking, Reputation, and the Underpricing
of Initial Public Offerings” (1986) vol. 15, nos. 1-2 Journal of Financial Economics 213-32.
28 See, for example, Robert E. Miller and Frank K. Reilly, “An Examination of Mispricing, Returns,
and Uncertainty for Initial Public Offerings” (1987) vol. 16, no. 2 Financial Management 33-38;
Christopher B. Barry, Chris J. Muscarella, John W. Peavy III, and Michael R. Vetsuypens,
“The Role of Venture Capital in the Creation of Public Companies: Evidence from the GoingPublic Process” (1990) vol. 27, no. 2 Journal of Financial Economics 447-71; and Jog and Wang,
supra note 24.
876
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canadian tax journal / revue fiscale canadienne
(2004) vol. 52, n o 3
master limited partnerships reports that the underpricing is not significantly different from zero.29 In another study, Wang et al.30 found an average first-day return of
-2.82 percent for a sample of 87 REIT IPOs.
Table 18 shows the number of IPOs by year and by sector. This sample represents 60 percent of all IPOs and almost 75 percent of all IPO financing. The 61 IPOs
in table 18 include the two for which we had no prospectuses.
Table 19 documents the evidence on underpricing for this sample of income trust
IPOs. The degree of underpricing is close to zero, in contrast to the 10 to 12 percent
underpricing documented by Jog and Wang 31 for Canadian IPOs. Except for a
slightly higher underpricing for 2003 IPOs, which was due to the existence of one
issue with a high degree of underpricing, the average underpricing is low.32 The
evidence also indicates that the market for income trust IPOs may be dominated by
equally (un)informed investors.
Table 20 shows the immediate (that is, within five days of the IPO date) aftermarket performance of the sample IPOs. These results are similar to those for
traditional IPOs. This evidence suggests that there is no imbalance between supply
and demand in the immediate post-issue days.
These results are what might be expected. Since income trusts are typically
created in mature sectors and promise to display “predictable and stable” cash flow
streams in the near to middle term, there is less uncertainty about the value of
income trust IPOs. Therefore, issuers do not have to “put money on the table” to
compensate uninformed investors.
Table 21 shows the post-issuance volatility of IPOs in 1997-2002 during the first
six trading months. The average volatility is less than 2 basis points for both price
return and total return (price plus dividends).33 This degree of volatility is considerably lower than that documented by Jog and Wang34 for Canadian IPOs (on average,
20 to 22 basis points). This comparison indicates that the income trust IPOs are
considerably less risky than a typical traditional IPO in the immediate post-IPO
period. This result may not be surprising if one views these trusts as stable dividendpaying stocks closely resembling preferred stocks.35
To investigate the longer-term performance of income trust IPOs, we investigated the total return performance during the post-IPO period. Figure 2 shows the
29 Chris J. Muscarella, “Price Performance of Initial Public Offerings of Master Limited
Partnership Units” (1988), vol. 23, no. 4 The Financial Review 513-21.
30 Ko Wang, Su Han Chan, and George W. Gau, “Initial Public Offerings of Equity Securities”
(1992) vol. 31, no. 3 Journal of Financial Economics 381-440.
31 Jog and Wang, supra note 24.
32 Also see Muscarella, supra note 29.
33 Aftermarket volatility is measured by the variance of daily returns in the period stated.
34 Jog and Wang, supra note 24.
35 This is conjecture; we know of no empirical evidence on the post-issuance volatility of
preferred shares.
the growth of income trusts in canada and the economic consequences
TABLE 18
877
■
Number of Issues by Year and Category
1997
1998
1999
2001
2002
2003
Subtotal
Percent
of total
Business . . . . . . . . .
Resource . . . . . . . . .
Utility . . . . . . . . . . .
Subtotal . . . . . . . . .
4
2
3
9
1
1
0
2
0
0
1
1
3
1
1
5
23
3
4
30
8
2
4
14
39
9
13
61
64
15
21
100
Percent of total . . .
15
3
2
8
49
23
100
Category
TABLE 19
Underpricing* of Income Trust IPOs
Year
Issues,
no.
1997
1998
1999
2001
2002
2003
Total
.....
.....
.....
.....
.....
.....
.....
9
2
1
5
30
14
61
Mean, Maximum, Minimum,
Standard
%
%
%
deviation,% UP = 0 UP > 0
0.69
-0.42
-0.50
1.98
1.74
4.11
2.04
6.67
1.67
-0.50
4.80
9.10
28.00
28.00
-5.83
-2.50
-0.50
-0.20
-4.00
-4.65
-5.83
3.71
2.95
na
2.00
3.79
8.08
5.00
3
0
0
0
3
1
7
4
1
0
4
17
10
36
UP < 0
2
1
1
1
10
3
18
na Not applicable.
* UP = underpricing. The last three columns indicate the number of issues for which underpricing
was zero, greater than zero, and less than zero, respectively.
TABLE 20
Average Return in the First Five Days After IPO
Year
Issues, no.
Mean, %
Maximum, %
Minimum, %
Standard
deviation, %
9
2
1
5
30
14
61
1.55
-1.17
-0.90
2.34
2.18
1.92
1.88
6.50
1.67
-0.90
5.86
14.02
9.26
14.02
-5.17
-4.00
-0.90
-0.12
-6.14
-5.02
-6.14
3.81
4.01
na
2.25
4.64
4.86
4.31
1997
1998
1999
2001
2002
2003
Total
.....
.....
.....
.....
.....
.....
.....
na Not applicable.
monthly values of investment in an equally weighted and a market-value-weighted
portfolio of income trust IPOs between 1997 and 2002 (excluding those issued in
2003) with an initial investment of $1.00. We have plotted the corresponding
performance of the TSX 300 index for comparison. As can be seen, an investor who
invested $1.00 in the first income trust and rebalanced equally as new income trust
IPOs came on the market would have seen the value of her $1 investment (excluding transaction costs) grow to $1.64, including reinvested dividends, by the end of
878
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(2004) vol. 52, n o 3
canadian tax journal / revue fiscale canadienne
TABLE 21
Aftermarket Volatility for Sample Income Trust IPOs,
Basic Points
Total return
Year*
Price return
No. of
issues
Days
1-20
Days
1-60
Days
1-120
9
2
1
5
30
47
2.14
2.54
0.58
1.16
0.94
1.25
2.61
2.26
0.73
1.12
1.11
1.44
3.21
7.24
1.22
1.06
1.21
1.84
Days
1-20
Days
1-60
Days
1-120
2.58
2.29
0.66
1.11
1.10
1.43
3.19
7.33
1.26
1.07
1.20
1.83
mean
1997
1998
1999
2001
2002
Total
...........
...........
...........
...........
...........
...........
2.14
2.71
0.58
1.16
0.92
1.25
* This table does not include 2003 IPOs because the return data for 2003 are unavailable.
August 2003. The corresponding number for a market-capitalization-weighted index
is $1.42. (The corresponding investment in the TSX 300 index would have grown to
$1.30 as of August 2003.) These results indicate that the smaller income trusts have
shown better performance than the larger ones. Figure 2 also shows the impact of
the technology bubble on the performance of the TSX 300 during the period 20002001. During that period income trusts showed little if any correlation with the
market index, and the systematic risks of income trusts were low or negative, indicating an attractive diversification opportunity. In addition, owing to lower than market
variations in returns, income trusts also provided a better return-risk tradeoff to
investors compared with the investment in the index.36
In summary, the results documented in this section show that income trust IPOs
have so far been an attractive investment security for Canadian investors in relation
to a passive investment in the TSX 300 index. It is not clear how long such performance can continue, but it is clear that these income trust IPOs have generated
healthy gains for investors in an otherwise unexciting period in the equity markets.
CONCLUSION
The emergence of and the recent growth in income trust financing have received a
great deal of attention. We have noted some theoretical and practical reasons that
partially explain this growth. However, our principal focus has been on three specific
aspects of the Canadian income trust market.
First, our analysis of income trusts as of August 2003 indicates that the total
financing by income trust IPOs and subsequent issues, excluding investment trusts,
amounts to almost $27 billion. More than 90 percent of this amount was financed
in 1997 and during the period 2001-2003. The nature of income trusts has also
changed: business trusts are now as prevalent as resource and utility trusts.
36 This is not to say that the TSX 300 index is the right benchmark for income trusts; we cite it
simply as a possible investment choice that is available to investors.
the growth of income trusts in canada and the economic consequences
■
879
FIGURE 2 Monthly Income Trust IPO, Total Return
Versus TSX 300 Monthly Total Return
2.0
45
1.8
40
1.6
Dollars
30
1.2
25
1.0
20
0.8
15
0.6
0.4
10
0.2
5
0.0
Number of trusts
35
1.4
0
Dec. June Dec. June Dec. June Dec. June Dec. June Dec. June
1997 1998 1998 1999 1999 2000 2000 2001 2001 2002 2002 2003
Number of trusts
Market-value-weighted total returns
Equally weighted total return
TSX 300 total returns
Second, income trusts have accessed capital markets for subsequent financing.
Income trusts are not only financing mature, no-growth, one-time businesses but
are also aggressively raising capital for capital expenditures and new acquisitions.
Over 50 percent of new financing has gone into new acquisitions and capital expenditures. These trust vehicles may not be impediments to economic growth; if there
are attractive opportunities in the underlying operating companies, they will access
(and have accessed) capital markets for additional financing. However, we have no
direct evidence on whether these investments have been value-creating. We are
surprised to find that there is an absence of information on the uses of proceeds for
almost 40 percent of the capital raised in subsequent financing. However, this
overall evidence may comfort “free cash flow” agency theorists who would cite it
as proof of well-functioning capital markets notwithstanding the obvious tax advantage of the financing vehicles.
Third, income trust IPOs have proved less risky than the traditional IPOs; they
have demonstrated a low degree of underpricing (which was expected), low postissuance aftermarket volatility, and relatively better rates of return.
880
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canadian tax journal / revue fiscale canadienne
(2004) vol. 52, n o 3
Although we have not focused directly on the tax and tax revenue implications
of income trusts, our results indicate that almost one-quarter of these financings
may have no implications for taxes and tax revenues because they replace existing
indebtedness. Another 20 percent (assuming that the other half of the 40 percent
goes to new capital expenditures) of these financings also generate capital gains
taxes because they are used to acquire owner interests. Nevertheless, further indepth research and analysis is required to quantify the tax revenue implications of
income trusts.37
37 For example, a possible change to the tax system may be to introduce a “see-through” rule
whereby the interest income received by income trusts is treated as such when received by
investors even if it is called a dividend. It may also be possible to adopt a system of “franked”
dividends whereby each investor receives a tax credit based on the taxes paid by the corporation
that distributes the dividends. In this case, the tax-exempt investor would not get a benefit of
the tax credit. Given the opposition by pension funds to the proposed legislative changes to the
income trust environment, the success of such measures is questionable at best. Since
discussion about tax policy implications of income trusts is a complex issue and is outside the
scope of this paper, we refrain from pursuing it any further.