PricewaterhouseCoopers LLP released its report on intial public offering (IPO) activity in the Canadian stock market along with the prediction that IPO activity will shrink substantially in 2007. This is a big deal for the Toronto Stock Exchange, the seventh largest stock exchange in the world.  It promotes itself as the market of choice for new issues and was, in 2005 at the height of income trust new issues, proud to be the third strongest market for new equity issues. But Pricewaterhouse reports that the Conservative government tax on trust distributions and onerous taxes on new trust issues has put a stop to that strong position and potential for the TSX.

Specifically, the report suggested that IPO values could fall from $5.4 billion in 2006 to less than $3 billion in 2007. With all the policy uncertainty about trusts at the end of 2005, the issues of new income trusts fell in 2006 by $1.4 billion from the prior year.

During 2006, the largest equity issue was the Air Canada offering worth $525 million while the largest income trust offering was a $700 million issue by Ontario-based Teranet Income Fund.

Ross Sinclair, heads of the company’s IPO and income trust services group and said that, “Without a clear view of where the market for new issues is headed, companies have shelved plans for equity financing through the capital markets. Investors are still looking for a place to invest and companies still need capital to grow. They’re just not meeting on the [Toronto Stock Exchange].”

On October 31, 2006, the Finance Minister, Jim Flaherty announced new taxes on trust distributions. And the fourth quarter of the year turned into a disaster for the TSX in terms of new business from new issues. There were only five companies that made new issues, with none being an income trust. By the end, trusts accounted, none-the-less, for approximately 60% of the $3 billion market growth through new issues. Had there been no tax slap on flow-through entities, and income trust issues might have matched their level of contribution to the market of 2005, when trusts accounted for nearly three quarters of the new issues.

Pricewaterhouse provides further context for the economic implications of this meltdown in market expansion.  The report says that the new issues outlook for 2007 is now “very dim” with the problem being that, now with new taxes, small and medium sized companies cannot access public money through the tax-efficient trust structure that once provided such an effective vehicle for financing Canadian business growth.

The obvious conclusion from Pricewaterhouse is that the range of choices for investors has narrowed due to the collapse in new issues.  But given the trust tax, many companies with trust issues are and will be taken private.  Furthermore, companies that seek financing may now find it more affordable to seek foreign or private investors than to undertake the costly process of issuing shares as a regular corporation.

With many trust naysayers talking about the market bubble bursting due to inherent problems with income trusts, there have been years of talk about some peoples’ hope that trusts would go away so that markets could return to their traditional ways and forms of securities.  In 2006, it was proven that only punitive taxes by the Canadian government could hurt the value of income trust securities, rather than there being inherent problems. But trust cynics go there way.

The Pricewaterhouse report predicts that 2007 will be the worst year for market growth through IPOs since the 2001 “dot-com crash” when new issuers raised barely more than $2 billion in Canada.