A big Calgary-based closed-end fund-of-funds trust has devised a plan that it hopes will address the concerns of its unitholders, who have long complained that they are short-changed when the trust acquires new assets.
The new plan applies to the exchange offering of EnerVest Diversified Income Trust, managed by Vancouver-based Cyprus Capital Management Ltd. The mid-October offering — the tenth by EnerVest since 1999 — seeks to raise $500 million.
EnerVest has a market capitalization of about $1 billion and net asset value of about $1.4 billion.
The problem for existing Ener-Vest unitholders arises because of the nature of a closed-end trust — specifically, that its units tend to trade at a discount to their NAV — and how EnerVest acquires new assets. Under the new plan, existing unitholders have been offered warrants that give them the right to purchase additional EnerVest units at a significant discount to their trading price. This offer is designed to compensate unitholders for any dilution in value of their units as a result of the exchange offering.
Here’s how existing EnerVest unitholders can find themselves in a pickle without these warrants.
EnerVest defines itself as “an actively managed, closed-end trust that invests in a diversified portfolio of income, royalty and real estate investment trusts, limited partnerships and corporations or other securities.”
As part of EnerVest’s strategy to expand its assets under management, the fund markets an exchange offering, usually annually. Under these offerings, non-EnerVest investors who own income trusts, royalty trusts and other securities are given the opportunity to swap some of these holdings for units in EnerVest.
EnerVest publishes the list of securities it would, in effect, agree to buy from non-EnerVest investors. The exchange offer remains open for a period of time and EnerVest buys the units being swapped at prices based on the 20-day weighted average trading price. (In its current transaction, EnerVest shortened the term during which the exchange price is determined to three days — a move aimed at ensuring less volatility about the exchange price.)
But for EnerVest’s existing unitholders, there is a problem with that approach: their holdings are diluted. That’s because the exchange is carried out at the market price of EnerVest units. As with closed-end funds in general, the market price of these units is traditionally below their fundamental value, or the value that would be obtained if the fund was wound up and the proceeds disbursed to its existing unitholders.
That dilution can be hefty. As of Oct. 10, for instance, the fund’s NAV was $4.48 a unit, while its trading price was $3.32 a unit — a difference of $1.16, or a 25% discount. So, if the exchange was done on that day, the “new” EnerVest unitholders would be in effect paying $3.32 to acquire an asset whose NAV was $4.48.
In short, the new EnerVest unitholders get a pretty good deal.
The new plan attempts to correct that problem. After the exchange offer closes, EnerVest will offer its existing unitholders warrants that allow them to buy inexpensive new units. The number of warrants to be issued will be directly related to the size of the exchange offering. For instance, if the exchange offering raises $50 million, then existing unitholders will receive one warrant for each 40 units held. But if $500 million is raised (the maximum sought in the offering), then one warrant will be issued for every four EnerVest units held.
One warrant grants the holder the right to buy another EnerVest unit at a 20% discount to EnerVest’s exchange price the day after the exchange offer closes.
“Existing unitholders will have the ability to invest incrementally, in a discounted fashion, in the growth and recovery that the manager anticipates will follow from current weak market conditions,” says an EnerVest release detailing the plan, which it refers to as an “enhanced” exchange offering.
“The warrants are, for the want of a better word, compensation for part of the dilution suffered when EnerVest does an exchange offering,” says Leslie Koroluk, EnerVest’s vice president of investor relations.
It’s too early to tell whether EnerVest’s innovation will catch on with other fund-of-funds companies when they do exchange offerings. Diversified Income Trust, managed by Toronto-based Sentry Select Capital Corp., has raised capital in the past via exchange offerings, most recently in October 2007, when it raised more than $300 million. Diversified IT’s reps declined to comment on whether if would consider a similar “enhanced” exchange offering.
@page_break@EnerVest has been around since August 1997. Since inception, it has posted an annual compound rate of return of 8.1%, which is 82 basis points above the gain for the S&P/TSX composite index during the same period.
Among its top 10 holdings as of Sept. 30 are Keyera Facilities Income Fund (6.2% of AUM), Canadian Oil Sands Trust (6%), Altagas Income Trust (5.3%); Inter Pipeline Fund (5.3%), Canadian REIT (4.8%) and Yellow Pages Income Fund (4.8%). IE
Compensating for a dilution in value
New plan from EnerVest Diversifed Income Trust is designed to help existing unitholders
- By: Barry Critchley
- October 28, 2008 October 30, 2019
- 12:30