Trust tax topples Canadian IPO market

The number of Canadian initial public offerings has been decimated by the devaluation of income trusts, according to a PricewaterhouseCoopers market survey.

There were just 37 IPOs on the TSX and TSX Venture exchanges in the first six months of 2007, with a total valuation of $855 million. This is down from the 57 new equity offerings, which had a value of $4.0 billion, during the same period of 2006.

“The interesting theme about this year is how dramatically down the IPO market is. That’s in contrast to a broader stock market that’s in relatively good shape,” says Ross Sinclair, national leader for PwC’s IPO and income trust services. “It’s an anomaly we haven’t seen in a while.”

Sinclair attributes the decline in IPOs in large part to the devaluation of income trusts that resulted from the federal government decision to heavily tax their distributions.

“When you take away something that used to affect 75% of the IPO market, it has a big effect,” he says. “In 2005 and 2006, income trusts probably represented 60% to 70% of IPO activity overall. In order to give you a sense of the magnitude of this loss, there were around $5 billion to $7 billion of IPOs during those years, and now we’re looking at less than $1 billion for half of the year for 2007.”

This year’s largest IPO wasn’t even a Canadian company, he notes, but rather a high-dividend-yielding U.S. corporation, Northstar Healthcare Inc., which was able to capitalize on market demand for high-yield alternatives to income trusts.

“The $148 million placement by Northstar Healthcare Inc. is noteworthy because it is an issue by a U.S.-based company utilizing a structure not common to IPOs,” says Sinclair. “Using some non-traditional cross-border tax structures, it moves its income out of the U.S. into Canada. It doesn’t have any operations in Canada.”

Northstar is an exception, though, he says. Investors should not expect a trend of U.S. IPOs coming to Canada.

“I don’t think that every U.S. operation is going to have those [tax] circumstances or even want to raise funds in Canadian markets,” he says. “This offering is an interesting and unique development which is not necessarily the start of a trend, but it is testament to the desire in Canada for a higher-yielding equity product — the market that used to belong to income trusts.”

Sinclair says the only other point of interest with the current market is that IPOs on the TSX Venture Exchange are tending to have higher individual offerings.

“While the numbers aren’t large, the activity on the TSX Venture exchange suggests that the source and size of these placements is changing,” Sinclair says. The average size of new issue on the TSX Venture jumped to $8 million so far in 2007, up significantly from the average of $4.5 million in all of 2006 and $4 million in 2005.

Sinclair says these are just a blip, though, compared to the value of trust IPOs in previous years.

“Double a small number is still small,” he notes.

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com