Explanation on CI Investments income trust conversion

Equity isn't the same as equality: Sun Life's stake in CI Financial gives it a leg up
National Post Thu 25 May 2006 Page: FP2 Section: Financial Post Byline:
Barry Critchley Column: Off The Record Source:
Financial Post

It's been known for years but now it's official: Some shareholders aredeemed more important than others. Consider the situation with the process that will see CI Financial Inc. convert to an income trust. CI will make that conversion by way of a plan ofarrangement, meaning that the conversion will be subject to a vote by shareholders. (The vote is on June 22.) Sun Life Financial is CI's major shareholder, with a 35% stake. CI's shareholders will be offered a couple of choices when they switch from owning a stake in a public company to owning a stake in an income trust: - A unit of the trust; or - A combination of class B limited partner units (the so-called exchangeable LP units) of Canadian International LP and special voting units of the trustand (possibly) units. Some short-term limits have been placed on theexchangeable shares. However, the public shareholders will be limited in their ability to receive the exchangeable LP units The reason: According to CI's news release, Sun Life "will be afforded the right to receive exchangeable LP Units in priority to other CI shareholders (the so-called minority shareholders.)" At this stage, it's not known how many exchangeable shares will be offered.The number apparently depends on a formula, given that an income trust ismeant to be designed so that it doesn't pay tax. But however many are issued, first dibs will go to Sun Life, which acquired its stake in CI via a two-step process: Initially it swapped its mutual fund assets for CI shares; later it topped up that stake with the purchase of shares from two CIinsiders. Exchangeable shares are attractive because they allow a tax-free rollover. That means the holder can defer capital gains for a period of time. (In this deal, the exchangeable shares effectively have no term. In short, they are perpetuals, a characteristic of common shares.) Exchangeable shares have been issued on a number of occasions in recent years. They are typically issued when a foreign company acquires a Canadian company, such as when Merrill Lynch purchased Midland Walwyn in the late 1990s. Hands up those who don't want to receive an exchangeable share? Exchangeable shares are in all aspects -- except one -- akin to regular common shares. The one difference: Exchangeable shares, which are listed on an exchange, come with a term to maturity. To maintain a listing, a minimum number of shares has to be outstanding.Given that Sun Life will be the main holder and given that it regards CI asa core holding, the chances are that the exchangeable shares will beoutstanding for many, many years. And even though CI admitted that Sun Life had been given preferential treatment in the conversion, the deal has been given the go-ahead by aspecial committee of CI's board of directors. That committee -- which consisted of independent directors, in essence thoseindependent of Sun Life -- concluded that the arrangement is in the best interests of CI and its minority shareholders. The special committee was advised by Genuity Capital Markets. That firm opined that the transaction isfair to the minority shareholders from a financial point of view. The circular will make it clear how much Genuity was paid for that opinion. So if the fundamental principle is that all shareholders are equal --and have equal rights -- what is there about an income trust conversion that mayput that principle at risk? The short answer is that it was a requirement for the deal to proceed. Given that Sun Life's stake is more than one-third, it has enough firepower to block the transaction -- which requires the support of two-thirds of theshareholders. Sun Life's ownership stake will count as part of meeting thatcondition. Accordingly, CI had to get Sun Life on side. While it had enough of a stake to block the deal, it also wanted a tax-free rollover, given that it alreadyreceives dividends on a tax-free basis. And that's what it got. From CI's perspective, it came to the conclusion that the company was muchbetter off as an income trust than as a regular company. The reason: As a trust, it won't or shouldn't pay tax -- meaning it will trade at a highermultiple. As a profitable company, it will pay tax.