Category: Canada

Uranium One gets taken over

In a somewhat complex arrangement, Uranium One (which has a primary business of owning and operates several uranium producing mines in Kazakhstan) announced a transaction with its existing 23% owner, JSC Atomredmetzoloto (ARMZ, a Russian corporation that is state-owned by the Russian Atomic Energy Corporation) such that Uranium One will receive an economic stake in two more mines and ARMZ will receive a majority stake in the company.

The salient details are in the press release.

Although I do not have a current position in Uranium One equity or debt, I do keep an active watch of their debentures. They traded up from about 92% to 94% after the announcement. The debentures have a change of control provision, but this is for 2/3rds of the company and not majority ownership.

When dealing with majority-owned companies, you have to be very careful in knowing the motivations of those shareholders – their goals and interests might not line up strategically with the interests of the minority shareholders (which is either to derive an income stream or realize capital gains in the marketplace). As such, you should never own companies that are majority controlled unless if you can answer this question. Some majority owners are there to pillage or otherwise legally transfer the assets of a subsidiary company into a parent corporation and some majority owners like to depress the market valuation of the subsidiary firm just so they can acquire the rest of it. It is rare when the alignment is correct (i.e. the majority owner wants to sell the rest of the stake for a high price, or the majority owner wants to peacefully derive as much long-term income out of their investment).

For shareholders, I would be extremely cautious in the future about Uranium One.

Fortunately, the debenture holders do not really have to care about the motivations of shareholders (other than their willingness to pay off the debt). Even after the proposed special dividend the company is proposing, the corporation will have sufficient liquidity to pay off the $155M of debentures when they are scheduled to mature on December 31, 2011. At a price of 94, they have a current yield of 4.5% and a potential capital gain of 3.9% annualized assuming redemption at maturity.

Both shareholders and debenture holders also realize the same risks with respect to having a Canadian corporation owning and operating mineral rights in foreign countries. I have no idea as to the political stability of Kazakhstan, but would be slightly comforted in knowing there are a few directors on board that speak Russian and would have some clue about the legalities of their political system. However, I would not be comfortable as a shareholder knowing that a Russian government corporation controls the board of directors in the company. Their only vested interest would be to maintain control of the company, and at least this means they should be paying their December 31, 2011 debentures.

The state of the Canadian wireless telecom market

Back in the 1990’s, the players were the telecoms we know today (Telus, Bell) and three companies that the younger generation doesn’t know much of today – CanTel (which was taken over by Rogers), Microcell (which is most known as Fido, but was taken over by Rogers) and Clearnet (which was taken over by Telus).

Putting a long business story short, all the original competitors went away except for Telus, Bell and Rogers. Telus and Bell had their landline markets subsidizing the wireless capital construction, while Rogers had (and still has) their cable business. CanTel, Microcell and Clearnet were exclusively wireless providers and did not have enough financial capacity to remain as businesses. Microcell was the last holdout before it got munched by Rogers in 2004; although it should be noted that Microcell was in dire financial straits well before this date.

Fast forward ten years and the consolidation, and we now have some new entrants into the Canadian wireless market. They are Public Mobile (concentrating exclusively on the low end user of Toronto/Ottawa/Montreal); Wind Mobile (recently introduced in Vancouver and currently concentrating on a broad approach across metropolitan centers in Canada minus Quebec) and Mobilicity (in the same market space as Wind).

I predict that none of these companies will be making any money, but the consumer, over the next couple years, will be receiving some excellent deals for mobile voice/data service.

In particular, Wind Mobile should be a formidable competitor by virtue of having a deep-pocketed parent, Orascom. I am less certain that Mobilicty will last as long, simply because they likely are less capitalized. I have no idea how Public Mobile will do, but they appear to have a very low cost approach which may work simply because the major companies have too much fixed overhead to compete properly (on a cost basis) against Public.

I also highly suspect that the reason why Shaw Cable is waiting so long to get into the mobile market (even though they have made the proper wireless spectrum purchases) is because they want to see who consolidates with who – or maybe consider its entry into the Canadian wireless market through a purchase once Wind and Mobilicity have lost enough money and want to give up.

So my deep suspicion is that Shaw Cable and the retail consumer will be the big winner in the Canadian wireless market over the next few years.

Eating a little bit of crow on interest rates

I strongly thought the Bank of Canada was going to raise 0.5%, and the futures markets were not inconsistent with this belief, but instead, they raised 0.25%. Global factors (including Europe) is likely the reason why they went for the more conservative rate hike. They have also said that future rate hikes are not going to be as quick as the markets anticipated:

In this context, the Bank has decided to raise the target for the overnight rate to 1/2 per cent and to re-establish the normal functioning of the overnight market.

This decision still leaves considerable monetary stimulus in place, consistent with achieving the 2 per cent inflation target in light of the significant excess supply in Canada, the strength of domestic spending, and the uneven global recovery.

Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.

Now that I have completely destroyed any credibility that I had on the issue of short term interest rates, I will give my new projection:

July 20 (raise 0.25% to 0.75%)
September 8 (raise 0.25% to 1.00%)
October 19 (raise 0.25% to 1.25%)
December 7 (raise 0.25% to 1.50%)

Between now and the end of the year, the prime rate will rise from 2.25% to 3.50%, and your average variable rate mortgage of prime minus 50bps will go from 1.75% to 3.00%.

There is no indication that these quarter point rises will stop in 2011; although the markets are now hinting the short term rate will level off around 2.75% (prime rate of 4.75%). This will clearly be conditional on how fast the economy recovers and the onset of inflation.

Bank of Canada Interest Rate projections

The June 3-month banker’s acceptance futures are trading at 0.89% at present.

This suggests that the short-term interest rates (the target overnight rate) will likely raise 0.5% to 0.75%. However, the banker’s acceptances generally are a quarter point over the prevailing target rate, which suggests the market is pricing an approximate 40% chance that the Bank of Canada will only raise 0.25%.

One month T-bills are at 0.23%, 3-month T-Bills are at 0.47%.

My justification for a 0.5% raise is simple – they want to make a statement.

I rarely have strong feelings about currency trading, but my guess is that the Canadian dollar will spike briefly on the announcement and then will go through a decline.

Most of the media thinks that the Bank of Canada rate increases will result in currency appreciation, but they will get the opposite results – low interest rates causes a lot of currency holding through carry trading. Since traders are on the margin side, a higher rate will result in currency outflows. It is likely the US dollar will be the one to rise relative to the Canadian dollar, so I’d get your cross-border shopping in sooner than later. You can also do “cross-border shopping” by buying US equities. The markets suggest that the US federal reserve will start raising rates around the beginning of 2011.

Canada ends the fiscal year with $47 billion deficit

The 2009-2010 year-end fiscal monitor is finally released. I will make some year-to-year comparisons.

From April 1, 2008 to March 31, 2009 the government posted a $2.2 billion deficit. In 2009-2010, the government posted a $47.0 billion deficit.

Revenues were down about 5% year-to-year, mainly attributable to a decrease in personal income tax and corporate income tax collections. The corporate side would have been a lot worse if it wasn’t for a huge recovery in the later part of the 2010 fiscal year.

The one interesting item is that the proxy for general consumption in the country, the Goods and Services tax, had a decrease of 0.2% year-to-year in revenues, so this is virtually unchanged. Similar to corporate income taxes, there was a huge surge in collections in the last part of the fiscal year.

On the expense side, government expenses were up approximately 17%. The bulk of this is attributable to the “economic action plan”, i.e. the stimulus package. The stimulus package, as projected in the 2009 budget, was approximately $23 billion, so one can infer that if it weren’t for the stimulus, the deficit would have been around $24 billion – a fairly manageable number.

Most notable is the 35% increase in Employment Insurance premium payments – mainly a function of increased unemployment, but also factored into this were government legislative efforts to enhance EI benefits for those that paid into the EI program for a lengthy period of time (7 years or over) receiving an extended amount of benefits.

My quick guess for 2010-2011 is that we will continue to see significant growth in revenues from the three main sources – personal income tax, corporate tax and GST collections in the 2010-2011 fiscal year. On the spending side, we will continue to see spending as well, and probably see a posted deficit of around $35-40 billion. This cannot continue indefinitely, otherwise Canada might face its own entitlement crisis. Although relative to other countries we are in better shape, we should be returning our fiscal balance to a mild surplus position and save some capital for future rainy days – which is more than likely to occur for the duration of this decade and beyond as the baby boomer generation retires.