Tag: BAM

Inter Pipeline / Brookfield hostile bid

Brookfield Infrastructure (TSX: BIP.UN) is offering C$17.00 to $18.25/share for Inter Pipeline (TSX: IPL).

Inter Pipeline is a relatively small pipeline operator, with well-placed lines criss-crossing Alberta and Saskatchewan with oil and gas and natural gas liquid refining capacity. They have spent a ton of money on a polypropylene plant which was a fairly game-changing move for the company strategically, representing a horizontal move into refining petrochemical products. The quantum of debt they took out to build this plant is such that their leverage is quite high given their existing financial situation. The rest of the pipeline business is solid. They had a storage operation in Sweden and Denmark which they also are in the process of disposing of.

I’ll reserve judgement other than stating that I have consistently noted that Brookfield tends to try to acquire things for about 15-20% less than what such entities normally would/should be bought out for. I’m not criticizing their actions (it works very well for them!) but if I was a shareholder in a target of Brookfield, I would be very cautious on valuation.

The next comparator in this space would be Keyera (TSX:KEY), which is in a similar space but its geography is concentrated in the Montney/Deep Basin area of Alberta (the area hugging east of the Rocky Mountains). Next up would be Pembina Pipeline (TSX: PPL) but they have been the positive recipient of the entrails of Kinder Morgan’s Canadian unit, and are considerably bigger in scope.

We have seen a ton of consolidation in the oil and gas space – just yesterday, ARC (TSX: ARX) and 7 Generations (TSX: VII) announced a nearly equal share swap merger. The list of individual names in the public space is shrinking by the week.

Statement on Brookfield Asset Management and its family of subsidiaries

Too complex. Bruce Flatt is undoubtedly a genius (in John Malone style), but compare Brookfield with the relative simplicity of Berkshire (despite Berkshire controlling a much larger asset base) and there is such a huge night and day difference. My general issue with large conglomerates with lots of partially owned but controlled subsidiaries is that you run into agency issues with the boards having common members, but having to guess which arm of the company is going to be advantaged (or whether it mostly flows to management).

So a long time ago, I excluded Brookfield and its subsidiaries from being investment candidates – too difficult. I’ve always taken a superficial liking to Brookfield Property Partners (TSX: BPY.UN) (their takeover of General Growth was well timed), but even that entity has a snake’s pit of issues relating to structure. There’s a whole bunch of other REITs trading on the TSX (and indeed the NYSE) that give property exposure with a lot less complexity.

Canadian preferred shares – commentary

Early 2016 was a good time to invest in Canadian preferred shares, and there was also a lot of carnage in the equity market at the time. Five-year government bond yields bottomed at 0.48% in February 2016, and you can see the damage it did to the preferred share market – ZPR is an ETF that tracks 5-year rate resets:

What is interesting is a well-timed entry on the bottom (not completely clairvoyant, but say $7.50/unit) and an exit anytime between October 2017 to 2018 would have netted a total return that exceeded the TSX with less risk. Of course, you can’t determine those preferred shares will do better than the TSX when you’re sitting at your computer console in February 2016!

Today’s investing environment has plenty of parallels – the 5-year interest rate has dropped to 135bps from 240bps back in October. If 5-year yields continue to drop further, there is a high degree of likelihood that preferred shares will also be sold down to levels seen in 2016.

The question is getting the timing correct.

A lot of retail investors get burnt by buying into a relatively high yield product thinking it is safe. While the yield itself may be safe (it has been awhile since I can recall a dividend suspension in the Canadian preferred share marketplace beyond Aimia and some really garbage split-share corps), the capital is most certainly at risk. It looks like a very easy leveraged trade on paper when margin rates are 2.5% and you see a financial instrument at 5%, but how much pain can you take when the yield goes to 6%? 7%? You’ve just lost nearly 17% and 29% of your capital, respectively.

Using a real example, investors in Brookfield Preferred Shares series 30 (TSX: BAM.PR.Z) back in September was trading at par, had a near-guarantee 4.7% yield, and a rate reset of 2.96% over the 5-year government bond rate. Some enterprising chap sees margin rates at 2.5% and decides to invest $50,000 cash to buy $100,000 of BAM.PR.Z. Now they’re sitting on $23,000 in equity plus $3,500 in accumulated dividends and they would have surely received a margin call (or would be very close to one). How much of the population out there is leveraged to preferred shares in this manner and are feeling nervous? How many will hit the sell button to take the tax hit and move away from this “guaranteed leveraged return”?

Ideally when they all want to cash out, that’s the time to get in. Doesn’t quite feel time yet.

Why the junk debt market is not dead yet – Alaris Royalty Corp convertible debt offering

Somehow the junk debt market is not dead yet – I see offerings like this (Alaris Royalty Corp. Announces A $100 Million Bought Deal Financing) – unsecured debt, 5-year term, 5.5% coupon, and 30% out-of-the-money conversion rate (noting that the underlying equity is already giving out a dividend at nearly a 9% yield at the closing price of the day the bought deal was announced).

Talk about a low return, high risk deal! That said, Alaris should be giving their underwriters (CIBC Capital Markets, National Bank Financial Inc., RBC Capital Markets and Scotiabank) full price for finding investors to actually buy this offering, let alone $100 million of it.

Just glossing through the preferred share markets, one can speculate on a better risk/return scenario. There are many examples I can give, but I will choose one at random. Believers in Brookfield Asset Management can pick up a preferred share series (e.g. TSX: BAM.PR.Z) and buy an easy 6% tax-preferred yield, with a reasonably decent potential for capital appreciation (it is trading well below par), and BAM’s underlying business provides significantly better inherent diversification, coupled with a much better credit profile.

Is the equity call option of Alaris’ unsecured convertible debenture worth it? Why not just buy the common instead and pick up a 9% dividend? I can’t see any realistic scenario where an investor would choose purchasing the unsecured debt instead of the equity – and if you think the underlying company was questionable, why invest in this at all?

No positions in any names mentioned, and most definitely not going to be in Alaris’ convertible debt at par!