IPOs return somewhat in the first quarter but investors remain skeptical

It’s not the flood some were expecting when the new year rolled around, but there is still some positive news: there have been more initial public offerings in the first quarter of 2017 than there were in all of 2016.

According to information from FP Data Group, five new-to-the-market companies have raised at least $30 million of equity capital so far this year. The five include Freshii Inc. ($144.2 million) and Superior Gold ($32.7 million.) Both companies share another distinction: they filed a preliminary prospectus late last year and priced their IPOs in the current quarter.

Persta Resources, a Calgary-based oil and natural gas exploration, production and development company, is also on the list. It went public on the Hong Kong Stock Exchange.

The quarter’s other two IPOs were Canada Goose Holdings — which manufactures and sells expensive retail winter outerwear and which raised the equivalent of $391 million — and Fairfax Africa Holdings, an investment holding company, aiming to “achieve long-term capital appreciation, while preserving capital,” by investing in securities of companies either based in Africa or business that deal with Africa. It raised $79.3 million.

While five companies were successful in going public, two potentially brand new issuers — Source Energy Services and STEP Energy Services — could not attract enough investor interest. In large part the uncertain outlook for the oil sector can explain that lack of interest. STEP and Source are both broadly defined in the oil field service business. Private equity firms owned both.

The stage has been set for another IPO in the second quarter: In mid-March BOS Solutions Holdings filed a preliminary prospectus. The company defines itself as a “leading North American provider of customizable and scalable liquids-solids separation services.” It also provides services to the energy industry.

Plans call for new capital to be raised from the public and for some current investors to sell part of their stake via a secondary offering. BOS’s major shareholder is from Luxembourg. No indication of how much BOS is after.

What’s not included in the numbers is the small number of companies which go public as a result of a transaction with a special purpose acquisition company. For the quarter there were two such deals (Acasta Enterprises and Alignvest) via a structure that has been used extensively in the U.S. but which arrived in Canada two years back.

Known as SPACs, they follow a familiar format: Capital is raised, management seeks out a target and subject to shareholder approval and the transaction then closes. In theory, it sounds very simple, but in reality it is more complicated. The reason: SPACs are very shareholder friendly and shareholders have a choice: they can remain as a shareholder or they can ask for their money back. If too many opt for the latter then the SPAC doesn’t have enough resources to complete the transaction — unless it can secure replacement capital very quickly.

IPOs are often seen as life blood of the equity markets, providing as they do the opportunity for a company to go public, to attract new capital from a wider group of investors and expand — and allowing the founders a way to cash out, over time.

For investors, IPOs represent the chance to buy a new name perhaps in a new and more growth oriented sector.

Against those two big picture themes, over time there has been a general decline in IPOs. Possible explanations include the increased burdens (regulatory and otherwise) of being public and the difficulty of building a business, in public, and meeting the short-term whims of the market.

Financial Post
bcritchley@postmedia.com

One of Canada’s biggest stock managers says bond spike no threat

The head of one of Canada’s biggest equity funds says the bull market in stocks has room to run because dividend yields will remain attractive even if bond yields move higher.

Martin Downie, manager of the C$17.2-billion Investors Dividend Fund, said there’s a persuasive case to be made for investing in stocks, even as the rise in bond yields provides an alternative for income-seeking investors. The fund jostles with the RBC Dividend Fund for title of the biggest Canadian mutual fund, according to data compiled by Bloomberg.

“Stocks are still very compelling even with the backup in interest rates,” Downie, 55, said in an interview at Bloomberg’s Toronto office. Ten-year Canadian government bonds yield about 1.7 percent, compared with the 2.7 percent dividend yield on the S&P/TSX Composite Index., Canada’s main equity gauge. That one-percentage point gap is about three times more than the average over the past decade, Bloomberg data show.

Downie said he wouldn’t be surprised to see a short-term pullback in stocks, but he forecasts longer-term annual returns of 6 percent to 7 percent even if the yield on the 10-year U.S. Treasury note rises above 3 percent. It was quoted at 2.4 percent at 4 p.m. on Thursday.

“That will be quite a bit better than bonds,” he said. “We’re not looking to shoot out the lights but we do think we’re in a secular bull market.”

The S&P/TSX is among the worst-performing stock markets in the developed world this year but Downie, who also manages Investors Group’s Canadian Large Cap Value Fund, said that means there’s bargains to be found north of the border, even if the U.S. has a stronger economic outlook.

“If I was shifting assets, I would be shifting probably a little bit more towards Canada because of the opportunities,” Downie said. “I would still be overweight the U.S., but that preference has migrated a bit more towards Canada.”

Stocks Sink

The S&P/TSX briefly slipped into negative territory for the year on Wednesday. Since its high on Feb. 21, the Canadian index has lost 3.1 percent due in part to a 12 percent decline in the price of oil over the same period.

Downie isn’t worried about falling oil prices — two of his top 10 holdings are pipeline companies TransCanada Corp. and Enbridge Inc., both of which have carried out multi-billion acquisitions in the U.S. giving them more exposure to the stronger U.S. dollar.

He describes himself as a bottom-up stock picker who looks for high-quality stocks that trade at a discount to their intrinsic value. He has been trimming banks from his dividend fund because he sees them as fully valued, although they’re still a core part of the portfolio. As of Dec. 31, Royal Bank of Canada, Bank of Nova Scotia and Bank of Montreal made up three of the four holdings in the Investors Dividend Fund.

The dividend fund, which is part of Winnipeg-based IGM Financial Inc.’s group funds, has returned 14 percent over the past 12 months, compared with 17 percent for the S&P/TSX, according to Bloomberg data. IGM Financial is majority owned by Power Corp. of Canada, part of the Montreal-based Desmarais family empire.

Downie, who manages C$22.1 billion in total, won’t disclose what individual stocks he likes now except to say that he’s looking at opportunities among industrials and consumer staples and is staying away from materials on the belief commodities are in a secular bear market.

 

Trying to get REIT investors to think like a property investor — and not a stock market investor

Joshua Varghese, a real estate portfolio manager at CI Investments, has taken a more than passing interest in the going-private transaction at Milestone Apartments REIT.

For starters, funds that he manages used to own the units before turning seller because of concerns about the REIT’s on-going needs for capital expenditure to raise equity and because of the conflicts, perceived or otherwise, by the presence of an external management contract.

“In my opinion, Milestone’s management, which received more than $100 million when the management contract was internalized last year, needs to take more out and give that to unit holders,” he said.

Varghese, who oversees real estate investing for the Signature High Income Fund and the Signature Diversified Yield Fund, is a believer in value investing. That’s the ability to buy stocks at a discount to their net asset value and hold them until they reach that level — a process that takes time to unfold.

It may not be the classic 50-cent dollars (more like 80-cent dollars) but owning an asset that pays a regular distribution and provides the opportunity for increased revenue, in line with inflation, is attractive. “It requires a strong management team which has good capital allocation skills to grow NAV,” he said.

In other words, to generate a return in REITS, investors need to think like a property investor — and not a stock market investor. All of which means that perceived wisdoms — including that REITs are an interest play, higher-dividend-paying REITs are more attractive investments, and REIT returns are macro-driven — need to be expunged.

“In a market driven (largely) by private markets, you have a very transparent view of the real estate’s true value,” he said.

As for that ‘true value,’ Varghese sees a “disconnect” currently, between the private and public view of real estate.

All of which leads to a discussion of Hudson’s Bay Co. which is either a retail department chain with substantial real estate assets or a real estate company on which retail stores, some of which are struggling, sit.

“Analysts are saying that we are not giving credit to a lot of the real estate now because the retail operations are not good enough to justify it. But some of the smartest real estate investors in the world have put their own capital into the real estate joint venture (with HBC.) They are saying this is the real value of the real estate,” said Varghese, noting that HBC’s share price is below the estimated value of the real estate.

Of the $2 billion of publicly listed real estate assets that Varghese oversees, about 30 per cent is invested in Canada, 60 per cent in the U.S and the balance in Europe and Singapore. Over time, the Canadian portion has been scaled back.

Varghese’s view is similar to that adopted by Vision Capital Corp., a specialist real estate manager which serves accredited investors. “We are looking to buy real estate cheaper in the stock market than we can in the real estate markets. And if we see the opposite then we can go short,” said Andrew Moffs, a senior vice-president and portfolio manager.

“We are NAV focused, we think long term take a private equity approach, but can have liquidity in 10 minutes,” he added that Vision’s approach contrasts with the yield-driven objective used by some investors, including retail. “The last thing we worry about is interest rates. We worry about supply and demand,” he said, adding that HBC was recently added to the portfolio.

Financial Post

bcritchley@postmedia.com

RBC, TD Bank investors to vote on giving bigger voice to smaller shareholders

Investors at two of Canada’s biggest banks will vote soon on whether shareholders with smaller holdings should have a bigger voice when choosing directors for the board — a move that investor advocates say would, if successful, be a big step towards “shareholder democracy.”

The proposal, included in the proxy circulars of both Royal Bank of Canada and Toronto-Dominion Bank after being submitted by a shareholder of both banks, asks the banks’ boards to adopt a resolution enabling investors holding a three per cent stake (and meeting some other requirements) to nominate a director to the board and to include nominees on the banks’ proxy voting form.

That’s lower than the five per cent threshold, by an individual or a group, required under current Canadian law.  

While there are existing mechanisms for shareholders holding five per cent of a bank’s outstanding shares to have their say on director nominations — such as requisitioning a meeting or submitting a shareholder proposal — those avenues can be costly and difficult to pursue, said Stephen Erlichman, executive director of the Canadian Coalition for Good Governance. His organization put forth a proxy access proposal back in 2015 similar to the one before TD and RBC, he said.

“There are various issues about how the system works today, and our proposal … tried to make it a fairer system and a system that would work better for shareholders.”

RBC said in a release on Wednesday that the board is recommending that shareholders vote against the proposal for several reasons, “including that it would not be aligned with the statutory proxy access rules set out in the Bank Act.”

In its proxy circular, TD also recommended against the proposal, saying the measure “mirrors the evolving approach to proxy access in the U.S. without taking into account rights already available to the bank’s shareholders in Canada.”

“The board of directors believes that the action proposed is not necessary or in the best interests of the bank and does not support this proposal and recommends that shareholders vote against it,” TD said.

The proposal will be put forth at TD’s annual shareholder meeting at the end of the month, while RBC’s will be voted on in early April.

Andrew MacDougall, a lawyer specializing in corporate governance at Oslers law firm, says it’s notable that this is the first shareholder proposal to introduce a proxy access mechanism similar to what has been proposed in the U.S. He said it has the potential to be a “forerunner of future legislative changes in Canada.”

“Because it’s the first, it will be very interesting to see how investors react to it…. That may drive the degree of support that this initiative gets in Canada compared to the U.S.”

However, MacDougall says, there are existing provisions in the statute which are less complicated than what has been proposed. Because of those existing options, he doesn’t see any “meaningful benefit” to this proposal for significant investors in an organization.  

Anita Anand, law professor at the University of Toronto and the special advisor to the Canadian Federation for the Advancement of Investor Rights (FAIR Canada), said she is disappointed that RBC is recommending against the proposal, but says it is significant that the bank is allowing it to go before shareholders for a vote (as the board has discretion and the option to reject it).

“I am optimistic, and I very much hope that other (public) corporations will follow suit, put these proposals in front of their shareholders, lessen the threshold percentage, and … the baby steps will hopefully lead to larger scale reform,” she said.

That both banks have indicated they are open to continuing dialogue on proxy access is also significant, Erlichman said.

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ISS holds firm and urges unitholders of Milestone REIT not to support the going private transaction

ISS, a proxy advisory firm, has not been swayed by the small (US$0.10) increase in the offer being made to unitholders of Milestone Apartments REIT, to change its previous recommendation.

As a result, it continues to argue that unitholders should not support the transaction after what it termed was an “underwhelming” 0.6 per cent bump in the offer price.

“On balance, the mildly revised terms of the deal and the most recent publicly available information relevant to the company’s industry dynamics and standalone prospects do not materially impact ISS’ initial analysis or warrant a change to our original vote recommendation,” it said in a note issued Thursday morning.

The U.S. based firm added that because its clients use ISS research to inform “the deliberations of their own proxy committees in reaching a vote decision (it), is reticent to change any vote recommendations in the final days of voting.”

ISS also offered commentary on the decision by four institutional shareholders, which own 16 per cent of the REIT, to support the transaction. “Notably, Manulife, the company’s second largest holder, was one of two shareholders (along with AGF Management Ltd.) that were publicly opposed to the deal back in January,” it said, when noting that “it is difficult to disregard what appears to be a sudden groundswell of shareholder support for the transaction,” following the higher offer.

ISS proffered two reasons: senior management at Milestone have agreed to certain financial concessions and commitments totalling more than US$7 million as well as not receiving the higher offer price on about 10 million of their Class B units.

“These commitments – which essentially account for the bulk of the increased consideration – may have mitigated some concern that management’s interests were not fully aligned with those of other shareholders,” the report noted.

The second reason for the newfound shareholder support “is a growing sense, among certain holders, of a heightened downside risk driven by concerns over management’s commitment to a standalone company.”

ISS issued its report the day after Milestone released its fourth-quarter financials. For Q4 and for 2016, ISS said that the REIT “experienced (a) solid operating and financial performance.”

Did we tell you about the flood of high yield borrowings by Canadian corporates?

It’s not just a trickle; it is a downright dam buster.

We can make that statement because in about a week the busiest quarter of high yield issuance by Canadian corporations will wrap up.

And those numbers, as prepared by Tim Lin, of FP Data Group, show a flurry of activity. As of March 22, the equivalent of $13.8 billion has been raised so far this year with the bulk of that (the equivalent of $12.9 billion) being raised south of the border.) In all there have been 17 high yield transactions so far this year – of which 14 were denominated in U.S. dollars and three in Canadian dollars.

To put that $13.8 billion into perspective, since the start of 2013, Canadian borrowers have raised a total of $77 billion – which means that 18 per cent of what has been borrowed over the past 17 quarters has been arranged in the past quarter. If borrowings were uniformly distributed (an impossible situation), 5.90 per cent (or $4.53 billion) would have been done in each quarter. Accordingly, about three tines the normal expectation, were done so far this year.

Another way to show how busy was the first quarter: there have been 148 high yield offerings since Jan. 1 2013, 17 (or 11.50 per cent) were done in the first quarter. The numbers means that about double the expected norm were done in the first 90 days of 2017.

And the amount raised, $13.8 billion, is about 50 per cent larger than the previous busiest quarter: in Q3 of 2014, $9.67 billion was raised. And the amount raised is more than four times what Canadian companies raised in the fourth quarter of 2016. For all of 2016, there were 26 high yield offerings, which raised $13.84 billion.

For the first quarter of 2017, two large financings stand out: the US$3.25 billion, two tranche offering by Valeant, and the US$2.2 billion dual tranche financing by First Quantum. Two other issuers (MEG Energy Corp. and Cott Holdings) have completed US$750 million transactions while Stoneway Capital scooped up US$500 million of 10-year debt.

Financial Post

bcritchley@postmedia.com

RIP Canada Savings Bond: Popular granny investment receives ignominious send off in federal budget

The Canada Savings Bond, once a prized interest-bearing gift from grannies everywhere will cease to exist.

The symbol of safe savings and a secure source of government funding since its creation, the year after the end of the Second World War, the CSB has been in severe decline since its peak in the late 1980s, losing ground to a plethora of competing retail investments.

Once valued at more than $50 billion, the program has declined to about $5 billion, and now accounts for less than one per cent of total federal market debt.

The government reviewed the program, and determined it would be phased out this year, with no new sales in 2017, according to the federal government’s budget document published Wednesday.

“Your grandmother bought Canada Savings Bonds, but nobody’s buying them anymore… There’s no point to keeping them around,” said Avery Shenfeld, chief economist at CIBC Capital Markets.

He said it will be cheaper and more efficient to roll the demand for Canada Savings Bonds in with other Canadian bonds, and added that there is “not a political issue at this point” because there alternative guaranteed investment products such as GICs.

“There’s a fixed cost (to the Canada Savings Bond program) that starts to loom large… You have to pay for all those nice commercials to tell people how to buy them,” Shenfeld said.

However, the Canada Savings Bond isn’t just a victim of its waning popularity, blamed on the proliferation of higher yielding alternative retail investments such as guaranteed investment certificates (GICs), mutual funds, and low-commission trading accounts.

Even with the precipitous decline in the bond program, there may have been sentimental reasons to maintain it — given Canadians’ connection to the certificates they proudly displayed in their youth, and held onto over the years in boxes and safety deposit boxes.

But it’s become expensive for the government compared to other funding.

“The program is no longer a cost-effective source of funds for the government,” the budget document declares.

What’s more, it says phasing out the program “will result in cost savings from reduced program management and administration costs and allow the government of Canada to focus on less-costly funding options.”

While there will be no new sales of Canada Savings Bonds in 2017, all outstanding debt will continue to be honoured.

The bond received a low-key sendoff. In the back half of the 278-page budget document, its ending was detailed on just one page — including a graphic that clearly illustrates its mountain-shaped boom and bust.

‘Drowning in dimes’: Not all Milestone Apartments shareholders impressed with new offer

If nothing else we now know the desire of some institutional shareholders to receive full value in a takeover is stronger than others.

Welcome to Milestone Apartments REIT, which announced Wednesday it had agreed to a revised offer from Starwood Capital while at the same time releasing “strong” fourth quarter financials. The buyer is offering an extra US$0.10 per unit bringing the offer to US$16.25. But the “cost” of the transaction will not increase because of concessions Starwood has extracted from Milestone insiders.

“We are drowning in dimes,” said one wag clearly bemused by what has transpired. But in a world where thinking big seems to have been forgotten, the price hike was enough to convince four institutional shareholders to vote for the transaction.

The shareholders — 1832 Asset Management L.P., Connor, Clark & Lunn Investment Management Ltd., Manulife Asset Management Ltd. and Vestcor Investment Management Corp. — own about 16 per cent of Milestone. (1832 is part of Scotiabank while Vestcor is the former New Brunswick Investment Management Corp.) In the past, some of these institutions were among the transaction’s strongest critics.

And based on what analysts are saying, the support from the Gang of Four, may be enough to get the transaction over the line.

After noting the “small victories” in the new offer, Neil Downey from RBC Capital Markets, expects the additional 16 per cent institutional support “will be sufficient to add momentum to the total number of unit holders who will put their support behind the Starwood offer.” Downey contrasted the US$8 million of concessions given up by management with the $105 million received when asset management contract was internalized last September. That payment was meant to cover seven years of work.

“This significantly boosts the probability that the transaction will succeed, in our view,” noted Michael Markidis, real estate analyst at Desjardins Securities. To succeed the transaction requires the support of two-thirds of all unit holders and half of the unit holders excluding those affiliated with the Milestone insiders.

In a note, National Bank’s analyst, Matt Kornack said, “In the end this is an underwhelming conclusion to what was otherwise one of the best performing REIT investments over the course of its existence.”

But all is not necessarily lost for those investors who believe that they were a little short-changed. So far ISS, a proxy advisory firm, has not yet issued a report on the new offer. Unlike Glass Lewis, another proxy advisory firm, ISS said unit holders should vote against the proposed transaction. And some institutional investors are bound to vote in accordance with what ISS says.

In a Feb. 22 report, ISS said the “fact pattern in the transaction indicates speed and certainty were prioritized over price.” It added the deal “proposes to crystallize value that looks low based on multiple analyses.” Finally it expressed “red flag” governance concerns because of the “lack of a market check and management incentives.”

Let’s give the final word to two unit holders who have no intention of tendering.

For one the revised offer doesn’t “properly recognize the value of the properties being acquired,” a point he explains by referring to residential real estate where houses are sold on the basis of recent prices, not levels of the past two years.

“And recent sales in (Milestone’s) part of the market place are at significantly higher premiums than what the assets are being sold for in this transaction, ” he noted, arguing the offer is short by at least 10 per cent. “The fundamentals of this business aren’t rolling over. The new offer is pathetic.”

The other was equally emphatic: There is “no reason” to tender.

Financial Post

bcritchley@postmedia.com