August 22, 2008 / 9:37 PM / 9 years ago

No smooth road to trust conversions

CALGARY, Alberta (Reuters) - Two cases, coming in less than a week, show that investors need to be wary as Canada’s income trusts, with their tax breaks set to end, convert themselves back into corporations.

The tax breaks ceded to trusts, which distribute most of their cash to unitholders, are to expire 2011.

That deadline, mandated by the Canadian government, is forcing the firms in the sector to begin making choices about what kind of company they will be when the tax holiday is up and what sort of gains or losses investors can expect to see as a result of those choices.

“There will be different structures that emerge though time,” said Cristina Lopez, an analyst who covers energy trusts at Tristone Capital. “It depends on the organization and the management’s thought processes.”

Lopez expects that most of the energy trusts, the oil and gas producers that dominate the sector, will largely wait until the last moment to make the switch to a new format to conserve the tax pools that can be used to shield taxable income.

Still, a handful of companies have already made their conversions, including two over the past few days, and the pair took decidedly different directions.

Bonterra Energy Trust BNE_u.TO, a small oil and gas producer, took the more unusual path, agreeing to buy a former telecom company under court protection from creditors.

It’s planning to use SRX Post Holdings Inc’s (SRX.TO) Toronto Stock Exchange listing to do a reverse takeover of its trust units, allowing its investors to avoid a tax hit on capital gains.

Waste-management firm BFI Canada Income Fund BFC_u.TO is taking a more conventional route. It said it will become a dividend paying corporation and focus on growth.

The market reaction to the two different moves -- which came just a few days apart -- highlights the risks and rewards for investors.

Bonterra said it will keep up its 32 Canadian cent monthly payout to investors, but as a dividend instead of the distributions offered by a trust.

BFI, which is looking to grow its business through acquisitions after the switch, plans to cut back from a monthly payout of 15.15 Canadian cents to a quarterly dividend of 12.5 Canadian cents.

The market reaction to the two schemes has been markedly different.

Since its August 15 announcement, Bonterra units have climbed 13 percent, closing at C$36.50 on Friday, rising as its payout scheme has the added advantage of giving investors access to lower tax rates on dividends (trust distributions are taxed as income).

BFI’s payout-slashing plan had a perhaps predictable result. Since making its announcement after markets closed on Monday, the units have shed 14 percent, closing on Friday at C$19.08 in Toronto.

“Because they announced so close to the other, it really shows a massive contrast,” said Les Stelmach, an analyst with Bissett Investment Management.

There have been a handful of trusts that have so far converted, with most making the transformation because they ran up against the growth limits imposed by the Canadian government.

Groupe Aeroplan Inc AER.TO, which runs frequent flyer and other loyalty programs, made the switch in June. Its shares have fallen about 7 percent since then.

Trinidad Drilling Ltd (TDG.TO) converted on March 10. Its shares have risen more than 20 percent following the change, coinciding with a rebound by most energy service companies.

As the cutoff date approaches, the corporate choices that dictate future values will command the attention of investors used to cashing checks from high-yielding energy trusts.

“I think you’ll see (the trusts) all try to pay some form of a dividend,” Lopez said. “The question will be for how long and how high it will be.”

($1=$1.05 Canadian)

Reporting by Scott Haggett; editing by Rob Wilson

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