Canada – Page 42

Canadian Taxes – Waiting for the T3

Anybody invested in income trusts should know that the T3 slip, a statement of income from trusts, is required for applicable trust holders by March 31 of every year. This is usually the last tax form to come in, and it will explain how much income (and what type of income) you received over the year.

The reason why the T3 slip comes so late is to give trusts sufficient time to finalize (and audit) their financial statements for the fiscal year.

Impatient investors that want to get cracking at their personal income taxes, however, can go to CDS Innovations’ website and get a sneak preview of most publicly traded entities’ allocation of income. T3 statements for the 2009 tax year can be found here. Just note, in theory, a trust can change the reported allocation on March 30, 2010 and one should never submit their income tax return using the preliminary data.

First Uranium raises expensive capital

The financial soap opera continues at First Uranium. On Friday morning they announced they have agreed to a private placement of between $125 to $150 million of senior secured notes. There are a bunch of stakeholders that are getting into this offer, including the major shareholder, Simmer and Jack, and also Gold Wheaton, who has a stake in the gold production of First Uranium.

The notes are convertible at $1.30/share and this will represent a substantial amount of dilution for existing equity holders, assuming conversion – about 48% dilution.

I was informed that the notes will have a 7% coupon attached to them.

Also in the announcement is that the CEO, Gordon Miller, will depart and be replaced by another CEO, Deon van der Mescht, who is currently the CEO of Simmer and Jack.

A relevant quotation is the following:

In addition, the Company is relying upon exemptions from the minority approval and valuation requirements of Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions, on the basis of financial hardship. The Company’s current payables do not, in the Company’s estimation provide comfort to wait for 21 days to begin closing the Offering. As previously announced, the Company’s financial situation has been severely compromised by the termination of discussions regarding certain financing options as a result of the decision to withdraw and subsequently reinstate the Company’s environmental authorization for the new Tailings Storage Facility designed to accommodate future tailings deposition at the Company’s Mine Waste Solutions tailings recovery project.

First Uranium, therefore, is very close to bankruptcy. If this deal falls through, then bankruptcy is guaranteed. There would be a process where creditors (including the debentureholders) will be able to make their claim on the assets in accordance with Canadian law. Simmer and Jack’s investment would have been completely destroyed in the process, which is why they had to take this very unpalatable deal in order to save their interest in the company – which by all means should be able to produce a substantial amount of revenues once the core operation commences.

If you are holding equity in First Uranium, you have virtually lost most of your value over the past couple years. This deal should probably stop most of the blood-letting, but it is at a huge cost to shareholders.

The market, seeing certainty on the horizon, bidded up First Uranium shares 13% to $1.68. This also provides a substantial conversion cushion for the private placement component of the convertible offering to succeed.

The convertible debentures also rose 12% to 77 cents on the dollar with this news. The convertible debentures are a $150M issue, with a 4.25% coupon and maturing on June 2012. I happen to own some of these and am not afraid of dilution – in fact, I prefer dilution.

If this deal succeeds, it is more likely that I will receive payback on my investment, especially since the maturity date of this new deal is later than the existing convertibles. It is not clear, without reading some sort of prospectus statement, whether the secured nature of these new notes would interfere with the payment of the unsecured debentures.

Of note in this press release is no quotations from any officers in question – probably because this deal was entirely organized without the management of First Uranium consenting to it.

Morneau Sobeco Income Trust announces corporate conversion

Morneau Sobeco specializes in outsourcing HR services. They have an annualized distribution of $0.94/unit, but they recently announced a corporate conversion which will take effect in 2011:

“Today, we are announcing our plans to convert to a corporation at the end of 2010,” said Bill Morneau, Executive Chairman of the Fund. “We intend to maintain our current distribution level for 2010 and provide an effective 10.6% after-tax increase in 2011 for unitholders taxable at the highest marginal rate.”

The conversion is being undertaken in response to the legislative changes enacted by the federal government that will apply a tax at the income trust level on unitholder distributions commencing January 1, 2011. The current monthly distribution level of $0.07871 per unit (or $0.94 per unit annualized) is expected to remain unchanged for the balance of 2010. Starting in January 2011, the monthly dividend level is expected to be $0.065 per share (or $0.78 per share annualized) with a sustainable payout ratio of 65% to 80% of cash flow. This dividend policy will facilitate the repayment of debt, while providing investors with an attractive yield. Going forward, the Fund’s intention is to continue to reward its investors with dividends in line with business performance. A special meeting of unitholders will be held in the second half of 2010 to obtain unitholder approval of the conversion.

A 94 cent to 78 cent reduction in distribution is a 17% decrease in distributions, and is somewhat less than what would otherwise be expected on an after-tax basis. It is not surprising that trust units are not trading too far down – about 3% at the time of this writing.

My valuation exercise on the company indicated they are trading at their fair value range, so I have not even bothered to place any orders for the units. The units are trading at $10.19 a pop, which is a 9.22% yield on their current distribution, or 7.65% in 2011. Given the risk involved, this is appropriate.

Federal Budget 2010 – brief thoughts

The budgetary cycle this year from both the federal and provincial government can best be described as “nothing changing, we are staying the course”.

The federal government, in particular, managed to crunch 424 pages of relatively little of political substance in their budget document. A lot of the documentation (as always) discusses the fiscal outlook which is interesting from a macroeconomic standpoint. In terms of government operations, the summary table, as follows, is what one really needs to look at:

Once you remove the effects of the stimulus package, spending continues to increase at a slow rate. This rate is actually a faster rate of spending when you compare it to the equivalent in the 2009 budget (the tables are different sizes in the documents so you will have to click on this image to see the numbers more clearly):

It is obvious that the non-action is highly political – if the government decided to slash and burn spending and government programs, the opposition would likely topple the government and force an election about “providing government programs to Canadians”. In a minority government, the status quo is the safest political approach, to the detriment of the rest of the country. It is only until a clear majority of the public and/or the Liberal opposition starts calling for real spending cuts (compared to the Mickey Mouse “we made tough choices” line given by the Finance Minister) will it be likely that we will see less largess in the present government.

Some commentators have noted that the government is heavily depending on revenue increases to balance the budget in 5 years (which is such a far-off time horizon that nobody will be kept accountable for this plan) – I think the revenue ramp is actually reasonable, not aggressive but not conservative either. It really depends on whether companies will start to hire people, but considering the government sees the big picture with respect to investment capital and corporate tax rates (which, federally, will be dropping from 18% to 16.5% in 2011 and 16.5% to 15% in 2012), this, combined with a reasonable stability in commodity markets, should help the country get back on track economically.

The last note is that interest rates will have a large effect on the bottom line – however, the government has assumed an accounted for a 3-month T-bill rate of 0.7% for 2010 and 2.4% in 2011, both reasonable projections.

“Wait and see” seems to be the message for this budget. It has been the least exciting budget so far in this government’s administration, but this is probably a good decision given the political constraints in the House of Commons. I am not happy with the huge expense ledger, however.

First Uranium gets whiplashed

I have written earlier about First Uranium’s woes – they had an environmental assessment permit that was critical to their business venture pulled.

Today they announced that they have it back.

This is what I was referring to the political instability risk concerning investing in companies that have major operations overseas – judging how burdensome the local government is very difficult unless if you are living there and have a “feel” for them.

First Uranium equity today jumped by 39% and closed the day at $1.81/share. This gives them a market capitalization of $300 million. Before this fiasco began, their equity was valued at about $2.50/share. I suspect their equity is under-valued, but I am not interested in the equity – I am interested in the debt. The equity still has other risks (dealing with governance, management compensation, composition of the near-majority shareholder, etc.) that I am not interested in taking. In addition, there still is the operational risk of actually being able to get the gold refining project up assuming anybody wants to finance the operation. The operation will likely be financed with some combination of equity and debt. Future dilution is something equity holders will face, but this is already baked into the relatively low share price.

The debentures are trading at bid/ask 68/71. Now with their business prospects significantly enhanced (providing that they can raise $100 million of capital that would be require to get the project going), I believe there is a material chance that these debentures ($150M par value) will be paid off at par in 2.3 years to maturity. I am guessing that once the project gets established and the revenues come in as projected (which will be substantial) that sometime in 2011 or early 2012, the cost of capital for the company will be considerably lower and I will get paid off at par. At 69.5 cents, the debt has a 23% annualized combined yield-capital gain for an acceptable risk.