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How the rich get richer in the income trust world

Almost a year after Ottawa’s tax announcement rocked income trusts, the best trusts are finding ways to grow, says the Money Reporter.

It has gone down in the financial history books as the “Halloween tax,” and it certainly sent a ghoulish chill down the spines of income trusts and their unitholders.

The decision to tax income trust distributions, announced by Finance Minister Jim Flaherty on October 31, 2006, completely changed the landscape for income trusts. One day, trusts were a wildly popular phenomenon with an unlimited horizon. The next, they found themselves fenced in by a clearly defined horizon — the year 2011.

The results have been predictable. Companies that were planning to turn themselves to trusts for the free tax ride scuttled their projects. Among existing trusts, a two-tier market took shape. The rich got richer, while smaller trusts fell back or even disappeared from the trust market altogether.

All well and good. But how do the rich get richer? That question is best answered with specific examples. We have several from one of the country’s leading advisories on income investments, the Money Reporter.

The landline combat

Exhibit number one involves the phone company. Or, the phone company’s sprightlier offspring, you might say. When BCE Inc. (TSX-BCE) and Aliant Inc. put their landlines businesses together in one income trust, Bell Aliant Regional Communications Income Trust (TSX-BA.UN) was born.

Later, BCE also transferred Bell Nordiq Income Fund and its Telebec and Northern Tel lines to Bell Aliant, giving the young trust all the advantages it would need to succeed in life. Thus Bell Aliant’s inheritance was a rural landline business running from northern Ontario to northern Quebec and on through the maritimes.

Yet Bell Aliant had a formidable task to perform: to secure its landline business from intrusions by cable operators. In major metropolitan areas, cable companies had been given the green light by the CRTC to slice into the market with lower prices, which the incumbents were prohibited from matching.

But the incumbents could hope to hang on to the rural areas.

Here’s how the Money Reporter describes the rural combat: “The cable companies liked the urban areas because the potential customers were so close to each other, and it cost little to string their wires from one customer to the next. By contrast, in the rural areas customers are much farther apart, and therefore more expensive to sign up.

“The incumbents already had their wires strung and long-term relationships with their customers. In essence, then, the new Bell Aliant trust represented a formidable bulwark against intrusion by the cable companies. Job one was simply to hang on to the wireline customers it already had.”

Job two was to compete in the sexier high-tech services that the cable companies offered. And that job got a lot easier this summer when the CRTC granted forbearance — that is, allowed incumbents like Bell Aliant to compete with the intruders by removing the regulatory restrictions that had crippled them in the urban areas.

An even better buy

Now, says the advisory, Bell Aliant can use its familiarity with its customers “to start adding higher-margin services. Internet and cable TV can be delivered over those wirelines.” That can be followed by higher-speed Internet, pay-per-view, cell phones and personal digital assistants (PDA) like the Blackberry.

“That’s where Bell Aliant is coming from,” concludes the advisory, “and that’s where it’s going. We like what it’s up to, which is why we rate it a buy, both for income and gains, just based on their business model.”

As we all know, the parent is only months away from being retired from the public stage by the Ontario Teachers Pension Plan and its partners. And that means its offspring could get one more benefit from the parental purse.

Somewhere near the end of the first quarter of 2008, the close of the BCE deal will release some $28 billion into the market. “To the extent that institutional investors, portfolio managers and retail investors will be looking to maintain a presence in the telecom sector, Bell Aliant is a worthy candidate,” adds the Money Reporter. And that, says the advisory, makes it an even better buy.

Going to Google

Our second story of the rich getting richer takes us straight to the Internet. It puts the old-time search engine and the new-fangled one together. Those would be Yellow Pages Income Fund (TSX-YLO.UN) and Google (NASDQ-GOOG).

Actually, Yellow Pages has not behaved like an old-timer at all. It has moved swiftly with the times, which is why it remains in the camp of the successful income trusts. But it should be even more successful, in the opinion of this advisory.

To see why, we’ll follow Yellow Pages off the page and onto the web. “Today, when a business buys a print directory ad from Yellow Pages, that business automatically gets a free website from Yellow Pages as part of the deal,” explains the Money Reporter.

That business is also categorized under one of many business headlines (Rental-Cars, Rental-Party Supplies, etc.) so that a search on the Yellow Pages site can narrow things down considerably. Plus the search can be pinpointed right down to a specific postal code.

That means the site adds measurable value for Yellow Pages’ clients. “And with that added value comes pricing elasticity,” says the advisory.

What could add more value than the biggest search engine on the Internet? Yellow Pages has struck a deal to become the first Canadian reseller of Google’s AdWords™. This service helps small and medium-sized businesses target customers.

When anyone goes to Google looking for information, a map or a service, ads of businesses related to that information, area or service automatically appear. The business pays for those ads only if the potential customer clicks on the ad.

And every time someone so clicks, Yellow Pages and Google both get a piece of the action.

“This is the new Yellow Pages,” states the advisory. “This is what you are buying if you invest in units of Yellow Pages Income Fund. We believe too many investors dismiss this company.”

Just as many investors are dismissing another trust from a supposedly “ancient or declining industry,” adds the advisory, which has one more brief but heartfelt recommendation to make.

Moving on

Davis & Henderson Income Fund (TSX-DHF.UN) has made its money in the cheque printing business for years. The general assumption is that this old-fashioned roll-’em-off-the-printing-press business is no longer a growth industry.

Perhaps it isn’t. But it isn’t all that Davis & Henderson does either. A little over a year ago, it acquired the leading Canadian company in the supply of information and transaction technology for the residential mortgage and real estate markets.

That’s a lucrative business. And it’s an electronic business. Like Yellow Pages, Davis & Henderson is moving on from the print business, says the Money Reporter. Good companies don’t let the grass grow under their feet, or the paper pile up on their desks, as it were. They get on with it.

That’s how the rich get richer. One way or the other, the trusts that are forging ahead intend to keep on rewarding investors up to and past the 2011 deadline. Halloween seems to hold no terrors for them at all.