CPP Investment board – 407 Highway

The CPP Investment Board announced it is buying a 10% stake in the operations of Highway 407 in Ontario – which is a toll freeway that is the outer loop of Metropolitan Ontario, a suburban route serving roughly Brampton to Markham.

The 10% stake is costing the CPP CAD$894 million. The CPP will also be acquiring another 30% stake by virtue of taking over Intoll, an Australian company, for roughly CAD$3.3 billion.

Is Highway 407 worth $9 billion total?

What is interesting is that the organization must report to SEDAR. Looking at their 2009 annual financial report, the 407 Highway has a debt of $4.8 billion, cash and equivalents (restricted or free) of $670 million, and equity of negative $1.08 billion. Not a stellar balance sheet, although the bonds themselves have a very long maturity profile and averaging about 5.7% interest.

On the income side, you have $560 million in revenues, and $116 million in operating expenses, leaving a yearly operating surplus of $444 million. Interest expense is another $275 million. Ignoring the other line items (depreciation, amortization and other capital expenses, plus taxes), you are left with an annual surplus of about $170 million.

Not that I like to criticize billion-dollar fund managers like the CPP Investment Board, but they obviously have something more strategic in mind if they are going to be spending this much money for a large minority equity stake at a price that appears to be 50 times present cash flows. There are a few mitigating factors, however.

The first is that Metropolitan Toronto is likely to grow, and with that is likely an increase in the suburb population – thus, traffic should increase. An increase in traffic also means the ability to increase tolls, which the organization does not need political authority to perform. The other deals with inflation-proofing: a toll highway is relatively insensitive to inflationary increases since you have little competition.

On the opposite side, if oil prices increase dramatically, or commuting takes a different shape, toll highways may not be a good business to be in.

Finally, there is political risk involved – if the CPP was able to take over a majority of the 407 operations (they are close with 40% currently), there will be a lot of pressure by the Ontario government to be able to lobby the federal government to recapture the rights to the highway. Although the CPP is an independent entity created by the federal government, one wonders how much political influence there would be.

In any event, the 407 Highway reverts back to the Ontario government after the 99 year lease expires. Although this lasts until 2098 (88 years from now) and I likely won’t be alive to see the end, there is a finite lifespan to this company.

The CPP is a very powerful player domestically with its $130 billion in assets – just over the scale of the Ontario Teacher’s Pension Board, which controls $96.4 billion in assets.

Is the CPP blowing this much money on a toll highway worth it? I think they overpaid, but they are probably just as desperate for yield as most investors are currently. This is possibly their best candidate to deploy $900M in cash, which is a telling statement on the entire marketplace.

Clearwater Seafoods buys 3 months of time

I wrote earlier about Clearwater Seafoods Income Fund and their solvency issues. They had two maturities due – a small one in late September, and a much larger one on December 2010.

I have been an interested spectator to see how this resolves. I am not interested in purchasing either their equity or debt.

The first announcement in this refinancing game was on September 28, 2010, when Clearwater came to an arrangement with the September debt holders.

Of the CAD$11.9M debt that was due, three of the debtholders consisting of a majority ($8.8M or 74%) of the amount agreed to extend the debt to December 15, 2010, with the penalty of raising the coupon from 6.7% to 10.5% and the accumulated interest to date.

The rest of the minority holders (26% or $3.1 million) will be paid off the interest and debt principal.

So the company managed to pay off $3.1 million of debt, and deferred $8.8 million for less than three months.

The big maturity coming up (December 31, 2010) is a $45 million issue, which trades as CLR.DB on the TSX, with the last quoted value of 88 cents on the dollar. The relatively large price suggests the market anticipates that there will be a refinancing at relatively attractive terms for the underlying company. If Clearwater manages to get around this debt hurdle, there are successive hurdles to be cleared in 2012, 2013 and 2014.

Lack of fixed income candidates

I’ve been scanning the entire list of exchange-traded debt and asset-backed securities, and the number of securities that are trading at a substantial discount to par you can count with the fingers of one hand.

On the US side, you have subsidiaries of Ambac, AIG, and SLM Corp.

On the Canadian side, you have Clearwater Seafoods, First Uranium, Holloway Lodging REIT, Lanesbourough REIT, Newport Partners, Priszm, Royal Host and Sterling Shoes.

All of these companies have significant issues, so an investment in the debt of any of these issuers involve a substantial amount of risk, including their ability to refinance. Right now is the most debt-friendly time to finance, so one wonders what would happen in the event of a slowdown in the debt issuance market.

Questrade offering bonds

I notice that Questrade is offering bonds to their clients. More interestingly, they have a comprehensive list of securities available with tentative pricing. This method of offering is a good step, although they probably will need to automate the transactions.

They claim to be offering it “commission-free”, but the commission is embedded in the bid-ask spread. For example, a Government of Canada bond maturing on December 1, 2011 (a year and a couple months away) is quoted at bid 1.28%, ask 1.26%. This is not bad when you consider that 1-year T-Bills have a yield of 1.23%.

One of the big differences between retail investing and institutional investing is that if you have $100 million lying around, you just can’t dump it all into Ally or some retail savings bank and get your 2%; with large quantities of cash, you have to pile them into government securities in order to get a risk-free return – in this case, locking away $100 million you can get about 1.23%, at least using end-of-September quotations. If you want 2% or higher, you have to go all the way out to December 2015 for Government of Canada debt (2.04% on the ask); if you are willing to settle for a province, Quebec has June 2014 issues for 2.06%.

A retail investor does have the option of putting money risk-free into retail facilities, and thus this makes investing in government bonds quite useless since typically GIC rates (of up to 5 years of maturity) will be higher than prevailing government bond rates.

Corporate debt is another story – you can find higher yields there, but will have to take the appropriate amount of risk, and/or be willing to take debt with very long terms to achieve the desired yield. Most of the interesting issues are also exchange-traded, which alleviates the hassle of dealing with somebody over the telephone.

Finally, Interactive Brokers has a system that enables automated transactions on bonds, but it strongly depends on the corporate issue whether you will have any liquidity available.

Cracking the real estate agent market

(Link to news story: MLS real estate deal ‘may force out agents’)

About thirty years ago, the stock trading business was cracked open when brokers could charge whatever commissions they wanted – the eventual result of this was automated stock trading and dirt-cheap commissions. A trade in the old days could cost $100 (and that was in 1970’s dollars), while today you can get them done for a dollar.

Essentially, the full-service broker was supposed to provide “value” in their advice to buy or sell securities, but there was an embedded conflict of interest – the broker made money by performing transactions, as opposed to giving good advice. Discount brokerages alleviate this problem by allowing individuals to make their own trading decisions.

The same trend toward discounting will happen to real estate transactions. Currently a typical commission scheme is 8% for the first $100,000 and 2% thereafter; so a transaction on a $500,000 place could be around $16,000 or 3.2% of total transaction price. Suffice to say, this is a huge liquidity penalty (not even including the property transfer tax in BC).

What value does a real estate agent provide? It is one of being a liquidity provider – trying to find somebody to purchase your property. They also provide some supplementary paperwork (mainly copied from templates), but you still have to engage in a lawyer and/or notary to get some other paperwork done to close the transaction.

It is debatable how much “marketing value” is provided by an agent, but what is clear is that real estate transactions are likely to become cheaper as service components become separated. Also, people that can actively shop their property around will likely be able to save significant amounts of money.

Reducing property transaction costs will strongly help to increase liquidity in the real estate marketplace, which would also increase the accuracy of valuation.

One of the primary reasons why I do not dabble in real estate is simply due to the lack of liquidity and the transaction costs. I’d much rather prefer to invest in companies that specialize in real estate since they are likely to have better skills in property management than I ever would.