[Recorded by Electronic Apparatus]
Monday, May 29, 1995
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[English]
The Chairman: Good evening, colleagues. The committee will resume consideration of Bill C-89, An Act to provide for the continuance of the Canadian National Railway Company under the Canada Business Corporations Act and for the issuance and sale of shares of the company to the public, also known as the CN Commercialization Act. We have one witness before us this evening, from Wood Gundy, Tom Woods, vice-president and director.
Welcome to the committee, Mr. Woods. I understand you have a presentation to make first. Please begin at your leisure. We will ask some questions of you after your presentation.
Mr. Tom Woods (Vice-President and Director, Wood Gundy Inc.): Thank you,Mr. Chairman and members of the committee. I'm happy to be here this evening to provide my comments on this bill and some of the related financial issues that have come up in your previous meeting and in the House.
My prepared remarks are available in both official languages.
I have spent my entire 18-year career in the investment banking department of Wood Gundy and during the past 10 years have specialized in the divestiture of government assets. I have previously appeared before committees of the House of Commons and Senate in connection with Telesat and Canada Post and have advised on several government asset divestitures.
Wood Gundy is one of Canada's largest investment banking firms and is owned 88% by the Canadian Imperial Bank of Commerce and 12% by Wood Gundy employees. The investment banking department advises companies and governments on how to structure offerings of securities for sale to investors, both institutional and individual. It also provides advice on how to purchase or divest businesses and on how to establish capital structure and other policies that will be acceptable to shareholders. Other departments at Wood Gundy are involved in the sales and trading of securities, as well as research on the economy, industry groups and individual companies.
From September 1994 to March 1995, Wood Gundy provided financial advice to Transport Canada in connection with the offer by CP to purchase the eastern assets of CN, as well as the feasibility of, and structural considerations relating to, a possible public offering of CN's shares.
On the role of an investment bank in an initial public offering of shares, investment banks provide three main services to companies considering selling shares to the public.
First, they advise on how to structure the company and the offering to ensure that the issue will be marketable and it will sell at the highest price. For example, in our work with Transport Canada, we provided advice on the following: likely valuation implications of including non-rail assets in the company going forward; capital structure, i.e. the marketability and valuation implications for various debt levels; share ownership restrictions; type of securities to be offered; board of directors composition; and dividend policy.
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Investment banks also purchase and resell the shares to institutional and individual investors in Canada and internationally. They also subsequently provide research reports to investors on the company's performance and outlook, and trade the shares in the aftermarket, often putting up their own capital to be of service to clients who wish to sell their shares expeditiously.
About Bill C-89, I would say that, although I am not a lawyer and played no direct role in the drafting of this bill, it appears that the bill covers ground that would be familiar to any investors who choose to read the bill before making an investment decision.
I will now address the clauses of the bill that are financial in nature and that have been referred to by members in previous meetings of this committee and in the House of Commons.
Clause 8, the 15% individual ownership limitation, states that no one shareholder, together with any associates, can own more than 15% of CN's shares. Investors are familiar with this type of restriction because it has, to our knowledge, been part of every public offering of shares of companies owned by the federal or a provincial government in Canada during the past 15 years. Examples of individual ownership restrictions for Canadian companies at the time of the initial public offering are as follows: Air Canada, 10%; Alberta Energy, 5%; Cameco, 25%; Nova Scotia Power, 15%; Petro-Canada, 10%; Potash Corporation of Saskatchewan, 5%; and Telus, 5%.
International initial public offerings of government-owned companies typically have such restrictions as well, with the range being 2.5% to 15% for the companies we surveyed.
We believe a 15% individual ownership restriction would neither dampen investor interest in a CN offering nor prevent investors from exercising considerable influence over the direction of the company. While it is true that what is referred to in the investment industry as a ``take-over premium'' would not be built into CN's share price, such a premium would be theoretical at best, particularly in the case of a company such as CN, which would be perceived by investors as an unlikely take-over candidate.
Our understanding from legal advice we have received is that paragraph 8.(4)(g) would not preclude a group of dissatisfied shareholders from voting out the board of directors. As long as such shareholders were acting in their own individual economic interests as investors rather than in concert, they would be able to vote a sufficient block of shares to restrain the actions of an under-performing management group. This is the assumption investors are operating under with their holdings in other companies that have such a restriction. Accordingly, the 15% limitation would not be perceived as entrenching management.
About the concern that paragraph 8.(5)(a) might leave a loophole for shareholders who are de facto associates, the legal advice we have received is that the words clearly provide CN's board with the ultimate discretion on whether two parties are in fact acting in concert.
In summary, we believe the 15% ownership limitation strikes the right balance between, first, the government's objective of preventing the outright acquisition or control of CN by a single party, such as a foreign rail company or another party which, if it experienced financial difficulty, could cause serious harm to CN; and second, the objective of not adversely affecting the success of the offering in terms of both overall demand for the shares and price.
A limitation of 15% would still represent a very large shareholding - i.e., in dollar terms - even for the largest institutional shareholders, and is at the high end of the range of such limitations in Canada and internationally. This latter point, combined with the fact that it is proposed there would be no foreign ownership limitation, would be perceived by investors to be progressive and therefore beneficial to the marketing program for the offering.
About paragraph 8.(1)(c), which deals with head office location, investors would not be troubled with the stipulation that CN's head office continue to be located in Montreal, nor with clause 15's requirement that the Official Languages Act continue to apply.
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Although requirements such as these tend to apply only to companies being divested by governments - both Air Canada and Petro Canada have such restrictions - investors understand the rationale behind them.
About clause 12 and CN's debt obligations, CN has approximately $2.5 billion of debt outstanding and has an AA minus bond rating. As you know, a bond rating is a benchmark investors use in judging the creditworthiness of a bond. Companies and governments with higher bond ratings can issue bonds carrying lower interest rates.
Bond ratings are tiered as follows; and this is in order of declining credit quality. AAA is the highest possible rating - AA plus; AA; AA minus; A plus; A; A minus; and so on down to C.
Bond ratings below.AAB minus - i.e., bonds in the.AA category and lower - are categorized by investors as non-investment grade. Most pools of funds have rules prohibiting or restricting the purchase of non-investment grade bonds - that is, bonds rated.AA or lower.
CN's bond rating would fall if the government sold its shares, because the implicit government financial support - even though the bonds are technically not guaranteed - would no longer be present. Most U.S. railroads have bond ratings in the.AAB category or above.
Based on discussions we have had with the bond rating services, we believe CN could achieve a .AA rating if it reduced its debt to approximately $1.5 billion. Debt of $1.5 billion would put CN in a position to achieve an interest coverage ratio - that is, the ratio of earnings it had available for interest payments adjusted for lease payments - of approximately 5.0 by 1996. The interest coverage ratio adjusted for leases is the principal, though not the only, measure the rating services use in evaluating the credit-worthiness of railroad bonds.
A.AAB rating would provide a reasonably high degree of assurance that CN could maintain continued access to the bond markets to fund its capital expenditure and bond maturities in the coming years. Moreover, this degree of assurance would be critical to the success of the contemplated public offering of shares and in the net proceeds the government would receive. Unless equity investors believe CN could achieve at least a.AAB bond rating, they would not be prepared to pay full value for CN shares.
Other issues; CN real estate assets.
We have advised Transport Canada that the overall valuation of the government's investment in CN would be higher if the real estate assets were dealt with separately. Investors in initial public offerings of non-real estate companies rarely pay full value for such assets. In addition, some investors would respond positively to a separation of rail and non-rail assets, because they would interpret this as a signal that CN intended to focus entirely on the transportation business.
Sale of shares outside Canada.
We believe the government would not receive full value for the CN shares if they were sold initially only in Canada. The contemplated offering would be the largest-ever equity issue by a Canadian company and should have broad appeal internationally as well as domestically. Limiting the marketing to Canada would also jeopardize the feasibility of selling 100% of the shares in one offering, as is contemplated.
Employee ownership.
Allowing employees to purchase shares in CN on a preferential basis would have a positive impact on the broader marketing program. Most public offerings of government-owned companies provide for employee participation at a discount to the public offering price for prescribed purchase amounts. For example, in Air Canada, employees could purchase up to $5,000 worth of shares for $3,700.
Mr. Chairman, that concludes my comments on Bill C-89 and related financial issues. I would summarize by saying I believe the bill does not contain any limitations that would cause undue concern among investors. I would, however, caution the government about introducing additional limitations at this time.
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While I believe the initiative CN has taken to improve its operations in recent years, together with the improved economic environment, should result in widespread investor interest for the issue, placing further restrictions on the company's flexibility carries with it the risk of jeopardizing the success of the offering.
The Chairman: Thank you very much, Mr. Woods, for your solid submission, which addresses the financial clauses of the bill.
For comparison' sake, back on page 5 you mentioned that CN has approximately $2.5 billion of debt outstanding and has an AA minus bond rating. Can you tell us what the outstanding debt might be and the bond rating of CP today?
Mr. Woods: Yes. CP has an A-minus bond rating for the majority of its bonds. I think everyone knows CP is a much larger company, referred to in our business as a ``conglomerate'', where rail and shipping are an important part of the business, but energy and other parts of the business combine to be about twice the size of rail and shipping.
We don't view it as directly comparable, but nonetheless it has debt today of about $4.6 billion on a consolidated basis. But that includes debt of all of the subsidiaries consolidated up and that provides a debt-to-equity ratio of about 40%, at the moment, versus CN, which is today at about 50%.
The Chairman: Thank you very much, Mr. Woods.
We will begin the questioning with Mr. Guimond.
[Translation]
Mr. Guimond (Beauport - Montmorency - Orléans): Mr. Woods, on line 126 on page 6 of your presentation, you say: La plupart des sociétés de chemin de fer aux États-Unis ont des cotes de la catégorie.AAB ou des cotes plus hautes.
Could you give us some example of what you mean by la plupart des sociétés de chemin de fer aux États-Unis? Are those companies comparable to the CN in terms of economic activities or are they short-line companies?
[English]
Mr. Woods: There are about ten large railways in the U.S. that have bond ratings. These for the most part are railways that are not short lines but are large railways comparable to CN.
I will read you the latest bond ratings for the largest eight or ten of these: Norfolk Southern, AA bond rating; Union Pacific, A bond rating; Conn Rail, A bond rating; Kansas City Southern,.AAB plus bond rating; Burlington Northern,.AAB bond rating; CSX,.AAB bond rating; Illinois Central, .AA bond rating; Santa Fé Pacific,.AAB bond rating; Chicago and Northwestern,.AA plus - that's a smaller railway - and Southern Pacific has a double.AA.
[Translation]
Mr. Guimond: Can you make that table available to the clerk so that we can have it?
[English]
Mr. Woods: Yes, absolutely.
[Translation]
Mr. Guimond: Still on page 6, line 127, you say - as a follow-up to the chairman's question concerning the $2.5 billion debt of CN - that if it were reduced to approximately $1.5 billion, CN could achieve a ``triple B'' rating. According to you, what is to be done to reduce a $2.5 billion debt to $1.5 billion?
[English]
Mr. Woods: I think one example is what Air Canada did. In 1988, when they did their public offering, the entire offering was by way of what is referred to as a ``treasury offering''. All the funds that were raised from the public went directly to the company.
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They were then able to use those funds to pay down debt, in some cases, and in other cases invest them in securities that had maturities matching the maturities of some of the debt. Investors would look at that and say in effect they had brought down their debt by the amount of money they had raised.
Here a similar thing could be done. We understand from the work we have done, which ended in March, the company has a considerable amount of assets it could divest before a public offering, or it could transfer them to a government-owned company in exchange for cash, which would have the effect of reducing the amount of that $1 billion down to some number.
To take an example just to discuss it, let's say that number was $500 million or $600 million. Then the remaining gap could be raised in the way Air Canada did, by a concurrent offering along with the offering of shares the government would be selling. In the case of CN, because much of their debt is not immediately repayable - the terms prohibit that until maturity - CN would have to take that money and invest it in other securities and as they matured, pay off the debt as it matured.
[Translation]
Mr. Guimond: Mr. Woods, you personally verified the financial statements of CN for a certain number of years - Your personal knowledge of the financial statements of CN covered what period?
[English]
Mr. Woods: Typically, in this case, we went back between five and ten years to get a sense for the cyclicity of the business, obviously placing a lot more emphasis on the most recent years. But I think we have a good sense, as investors will, of how this company has performed over five to ten years.
[Translation]
Mr. Guimond: I would like to talk about the financial statement of 1992. If you have a good memory, you will recall that in 1992, there were some negative forecasts in the order of about $900 million, taking into account severance payments to managers and employees of CN.
According to the financial statements of March 31, 1995, and although there had been, according to Mr. Tellier, around 7,000 layoffs and personnel reductions, there still was $564 million unspent that came from those negative forecasts, from the financial statements I told you about, and that was in the order of $890 million.
What will you tell potential buyers of CN shares? Does this mean that those $564 million will be spent in the coming months, which is physically impossible? What will you tell shareholders? Will there be more massive layoffs made in order to reduce those $564 million or, more probably, will those $564 million that were taken from the $900 million not be spent, causing thus an impact on the real debt figures of CN. Do you understand my question?
[English]
Mr. Woods: No, I understand.
The Chairman: But you're a lawyer.
Mr. Woods: I think I understand.
The announcement by CN in 1992 to begin a program whereby, I believe, a target of approximately 11,000 jobs would be reduced over a 3-year period, with the accompanying provision for payments to individuals of, as you say, some $890 million, is something we believe sophisticated investors will understand. A number of Canadian companies, as we know, had to go through that in the past several years.
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The way investors would look at that is beyond the accounting. I think they recognize that because analysts and institutions have had to review financial statements of companies before, the way they review it, in effect, is to do a trade-off of the number of employees who would receive payments - by an approximation of the average amount of payment to these employees, which the company has estimated in aggregate as some $890 million - and view a cash outflow over some period. I can't tell you precisely what the expectation would be, but it would probably be over a three-, four-, or five-year period. Naturally, at first blush, that will strike investors as a negative. That's a very large amount of cash that has to be expended.
On the other hand, investors will analyse the impact that will have on the company's competitive petition and its ability to reduce costs and to make money. They won't get too hung up on the year-in, year-out accounting entries of how those provisions are taken.
Probably more important will be the extent to which the company is on schedule with this program. If they fall quite a bit behind, that may reflect negatively, even though the amount of money expended for payments to such employees will be less because they'll have an accompanying negative benefit in ongoing costs.
So frankly, the sense we have from talking to investors is that the program today has put CN in a potentially more competitive position, notwithstanding the fact that they've had to expend a very large amount of money to reduce the workforce.
Mr. Gouk (Kootenay West - Revelstoke): First, I'd just like to get a little understanding of how these various debt credit ratings work. When you go within a category, say AA plus to AA, is that essentially the same size of movement, in terms of financial stability, as a move from, say, A to A minus? Are these steps relatively equitable?
Mr. Woods: I think the best way to answer that is to tell you where bonds are trading.
Mr. Gouk: I realize the market has its little vulgarities from time to time, but for an expert like yourself, looking at credit ratings - A, A plus, A minus, down into the Bs - are they relatively equitable steps?
Mr. Woods: They are relatively equitable. There's certainly a big gap between.AAB and.AA, because then you fall into the non-investment grade category, but they are relatively equitable.
Mr. Gouk: So right now CN is at the AA category?
Mr. Woods: They are at AA minus.
Mr. Gouk: That's four levels from the top.
Mr. Woods: Right.
Mr. Gouk: Are you saying just by virtue of the fact that the government are going to divest themselves - even though they have no responsibility for any of the loans to begin with - they will drop six levels on that alone?
Mr. Woods: Yes. It's interesting, if you read the bond-rating reports from the U.S. agencies today, their words - and I can read them if you're interested - are exactly that. The interesting thing is, however, even though the agencies have not already downgraded CN - because they're hesitant to do that until the public offering either occurs or is on the verge of occurring - the bond markets themselves have already started to bid the bonds lower, meaning the spread - their trading relative to government bonds - is almost like a.AAB, even though nothing has happened. If you get precise, it's trading at about a low A today.
It does make a difference.
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The institutions - and this applied even to Air Canada and other non-guaranteed crown corporations - even though the government was not on the hook, so to speak, for the debt, there was a comfort level, not to the same extent there would be if it was guaranteed, but almost to the same extent. There was a comfort level that if those bonds' interest payments became endangered, there would be some action taken so that the fallout in the market wouldn't reflect negatively on the country's credit. Whereas if there's no ownership, as there is not now in Air Canada and a number of other companies, the market views them just as they would view any other company.
Mr. Gouk: In terms of the real estate assets, do you have some general figure as to the asset value we're talking about? You used some figures. Is that essentially where you see the value?
Mr. Woods: No. The numbers I used a moment ago were just round numbers. The work we've done did not involve in any way near the kind of detailed review that has to be done leading up to the public offering.
However, the sense we got from discussing this topic with Transport Canada and the company was that the assets might be within a range of $400 million to $600 million or $700 million in terms of rough valuation now. If you're familiar with how real estate markets work, the ascribed value someone might give to an asset and the value that this might achieve in the market today can vary widely, particularly in a circumstance if the assets were to be sold under a rapid time schedule because the market dynamics change completely, but it's a considerable amount of real estate.
Mr. Gouk: Yes, I realize that. Of these assets, and you talk a range of $400 million to $700 million, do they have debt associated with them as well?
Mr. Woods: Some of the assets do have debt, but not a very large amount. The range I gave, which I stress is a very rough range, is net of.... I think there's about $92 million of debt. That's the number that stands in my mind with respect to some of the income properties.
Mr. Gouk: As you look at it then, if the government were to take those assets, they would also take that debt. So, in addition to paying CN for their assets, the real estate assets, that would be an assumption of debt that would occur at the time of transfer?
Mr. Woods: Well, the real estate assets in some cases are plots of land which don't have debt and in other cases are security interests in building some properties, either partnership interests of shares or direct equity interest. So the debt is assigned, in effect, to a company that owns that building. So, if to the extent that assets were transferred, what we're really talking about are land assets and shares or partnership units in buildings. The whole company or partnership would transfer so, de facto, the government would own shares or would own partnership units in an entity that would have some debt outstanding.
Mr. Gouk: Okay, but is this $92 million actual debt?
Mr. Woods: Actual debt, yes.
Mr. Gouk: They would assume that $92 million.
Mr. Woods: Again, not to put too fine a point on it, the government or whoever might buy the equity or the partnership, would own securities, would own equity in a company that would have this debt outstanding. So it's as if you or I bought a company, we would own the shares, but the debt wouldn't be debt of ourselves, it would be debt in the company that we own shares in.
Mr. Gouk: Are these assets all CN owned or are some of these crown assets entrusted to CN?
Mr. Woods: I'm not sure I understand the distinction. The assets that are in the CN organization are assets that are owned by CN as a company. If your question is how did the company get those assets, I must say I am not sure whether in all cases they acquired them by purchase or whether in some cases they were entrusted. I just don't know.
Mr. Gouk: You're not aware of any specific properties that are entrusted to CN that are crown assets?
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Mr. Woods: We didn't get into that. We reviewed the assets of the company in some detail. I must say we didn't delve into the means by which those assets were conveyed to CN historically. I just don't know.
Mr. Gouk: As a slight aside, how is it that Wood Gundy isn't involved in the coordination of the sale?
Mr. Woods: We hope to be. In our business, as in a lot of businesses, you'd like to win every assignment. We were delighted to win the advisory assignment back in September. The three firms selected are excellent firms and we hope there will be a role for us to play in the distribution.
Mr. Gouk: I won't even ask any facetious questions. I'm trying to get beyond that these days.
Mr. Nault (Kenora - Rainy River): I want to get into the issue of bond ratings, of CN being a AA minus and correlate that to the importance of regulatory change. When you deal with that, if you can go from a AA minus because the government happens to have part of the action and then of course sells the shares on the open market and leaves the regulatory regime alone...I would assume that's the analysis that's arrived at, where we would go down to a.AAB minus or something of that nature. If you factor in regulatory change and the improvements the railway industry itself believes is necessary to put the rail industry on a sound footing, in your estimation where would that put the bond rating?
Mr. Woods: It's not a perfect science. I must say that when we did the analysis in response to the question of how much debt CN could have to ensure or provide a reasonable comfort level that there would be bonds with an ``investment grade'' quality to them, we made the assumption there would be some regulatory reform. But when you look at the long list of criteria the bond-rating services use in coming up with a rating, it's far more extensive, as I think I implied in my comments, than simply looking at an interest coverage, which they will tell you is the most important thing. A number of other things, such as the regulatory reform, such as the company's ability to control cost, the cyclicity of the markets....
There's no question that when you read the U.S. bond-rating companies' comments today, they understand the business. They understand that when the U.S. regulatory environment is compared with the current Canadian regulatory environment, there's a gap. So we have operated under the assumption progress would be made on that.
It's hard to be precise if your question is the hypothetical one of saying what if regulatory reform doesn't move forward to a great extent or as rapidly as perhaps might be hoped; what does that do to the bond rating? It's hard to know. It certainly gets factored in. When you start layering in what I call problems - poor regulatory reform, poor earnings, higher than average debt - there's no question the.AAB investment grade bond rating starts to become a concern. But it's just one issue.
Mr. Nault: Let me run that by you. I know we're talking ``what ifs''. Let's assume for the sake of argument we get down to a $1.5 billion debt, which to our understanding is pretty well the norm or average in the North American railway system, for the comparable railways of equal size. So we're assuming the government would be foolish to leave CN on the hook for $2.5 billion and go out there.... They are going to signal that it will be down to $1.5 billion or something of that nature.
That means when you looked at the bond rating, or how it would be set up, you obviously had to look at a factor different from the $2.5 billion, because I think the government have already signalled they were going to get this company down to $1.5 billion, or somewhere in that neighbourhood.
What are the other criteria you're using to go from the AA minus, which is where it's at now? Is it all because we have the big daddy to bail them out at the end of the day, so they can't go bankrupt? We're putting them in the same sort of arena as all the other railways, we're having regulatory change and you say we've already factored that in, so what's the rationale for that big drop in the rating? I'm having difficulty understanding that, if the government is sending the right signal.
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Mr. Woods: I think I've picked up the gist of your question.
When you look at the railroad industry in North America, and that is the context within which the U.S. rating agencies, who are the decision-leaders, if you will, will look at CN's bonds in comparison with the bonds of other U.S. railroads, today when they look at CN, they quite frankly don't look at it as a railway, in the same way as they didn't look at Air Canada as an airline. They said to themselves, look, here's a company that happens to be in the railway business, with lots of outstanding debt, a cyclical history, labour tensions, and a regulatory environment that is not as good as that of the U.S., but this is a crown corporation. They asked themselves what if an interest payment date comes and for some reason the company doesn't have money? They make the assumption that the government will see to it that the interest payment is not missed. To my knowledge, there's never been a crown corporation federally that has missed an interest payment.
They take a slightly different view if the company is free and on its own. Then they begin to look at it in the context of the U.S. railway industry, where things such as regulatory environment, densities, costs and operating ratios at the moment don't stack up.
Mr. Nault: That was why I was trying to get a handle on what the criteria are that you use, because it's also a known fact that CN probably has the best infrastructure of any North American railroad. It's well built, it's well maintained, and it's superior by far to any other railway in North America.
So when you put it on the same sound footing with a good regulatory regime, and financially you put it at about 1.5, then you've given it everything it can possibly have. Of course, at the same time they have peace and harmony on the labour front with the five-year agreement, which should appease the investors.
So after saying all that, I'm trying to get a handle on why anyone would come out and say, well, even then, when it's turned over into private hands, we're going to drop the bond rating like a stone.
The question it inputs is a very good one, and that is, how do you come up with this? Those of us who are involved in the railway industry all know that CN has very good infrastructure.
Mr. Woods: It does, and I'd agree with all of the things you said. I think the rating agencies, who I guess are paid to be sceptical, would say low densities, high operating ratio.
So even with all the things you listed and it is hoped will come into being, there are still a few categories in which, quite frankly, any railway operating in Canada, by the nature of the country, is going to be perhaps a bit behind the U.S.
.AA is a very respectable rating in the U.S. railway business. How do you get to single A? Do you need to get to single A? Those are other questions.
Mr. Nault: Let me switch focus a little on this. We're very interested, at least from my perspective, in employee participation, the magnitude of that and the effect that will have on the investors themselves. Could you give us from your perspective what it means to do your normal Air Canada participation, or do we go a step further and have a little more elaborate a scheme? It has not really been laid out for us at this point how much of that is really going to be in play here as far as the employees themselves are concerned, because we really haven't seen the details. But could you tell us from an investor perspective how far you could go with employee participation to make sure they have a good solid say in what's going on, versus the more passive - buy a few shares and maybe it will prove to be a valuable investment in the future, and that sort of thing?
Mr. Woods: Yes, sure. There is now a long history of employee share plans, dating back to the British plans in the early 1980s and through all the Canadian divestitures that have taken place. Investors like to see employees have a stake in a company, and I think particularly in the case of a company where there has been a record of some labour debates through the years, as frankly there has been in the case of CN.
On the other hand, investors are alert enough to recognize when the employees are being, in effect, given shares. So although not a lot of time will be spent by analysts evaluating an employee share purchase plan, there's no question that to the extent the market thinks employees are reaching into their pockets to invest in the company, it has to send a positive signal, particularly in the context of some of the labour questions the analysts will have.
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But from the government's and the taxpayers' point of view, I think it's wrong to assume a more generous or even a creative plan that calls for the government and the taxpayers to subsidize in effect investments by employees.... The market will see through that.
It's important to have them there, but it's also important to have them put their own money on the line and at risk.
Mr. Nault: So you're saying that having a sort of reduction in cost per share is not necessarily a good thing.
Mr. Woods: I'm sorry...?
Mr. Nault: When you gave us the example of from $5,000 to $3,500 for the Air Canada employees, was that not necessarily a good instrument?
Mr. Woods: I think when you look back at all the plans that have been done, the benchmark we use as analysts is how much is the owner, whether it's the government or a company, in effect subsidizing? How much free stock is being given? When you look at all of the precedents, you see that subsidies in the order of $1,500 to $2,500 per employee who participates are about the norm.
The point I'm trying to make in a roundabout way is that to the extent that number might be on the high side of that range or outside the range, you're probably not gaining anything from the street in terms of benefit from employees buying it. How you get there is less of an issue, but I think the company and the government would be advised to come up with a plan that investors think is reasonable in terms of subsidy, yet still successful enough that a very large percentage of the employees decide to invest some money in the shares.
[Translation]
Mr. Guimond: Mr. Woods, on page 3, you give examples of Crown corporations which were privatized. The government, for its part, in its interpretation guide for the act, refers to the two most famous cases, which are, of course, Air Canada and Petro-Canada.
I come back to clause 8 which deals with the 15% limit for individuals. When it privatized Air Canada, why did the government set the limit at 10% and why is it setting it at 15% now?
[English]
Mr. Woods: In September 1988, when Air Canada was offered to the public, there were relatively few examples of Canadian companies that had been divested. The guidance the government and the company took was primarily the British examples, most of which were relatively low-percentage figures. I can get those figures for you if you're interested. Five to fifteen per cent was the band.
I honestly can't recall why 10% was selected rather than 7.5% or 15%, other than that perhaps it's a rounder number. But the effects of 10% or 15% in terms of the objectives of the government, to my mind, are not major. It's hard to be precise in saying whether 20% is better than 15% or 10% is better than 15%, but clearly.... In my prepared remarks I've discussed what the objectives are, but it's not something I think you can be terribly precise about. It's within a range.
[Translation]
Mr. Guimond: Mr. Woods, in your presentation, you said that you were not a lawyer and that you had not played a direct role in the drafting of the bill. But you are an independent consultant and your firm was one of three chosen by the government to help in its privatization project.
In Quebec, when we want to attack consultants, we have the saying: "A consultant is someone who borrows your watch to tell you what time it is". I hope it's not the way you will answer my questions.
.1925
Since you're independent, you have not had a hand in the drafting of the bill, can you tell us what clauses could be improved upon in the interest of a better understanding of the issue and in the interest of clarity? If you were the legislator, what amendments would you propose? Are there points that should be clarified in the bill?
[English]
Mr. Woods: One of the things we do in the role we sometimes play as advisors or consultants is to be careful to advise on things we think we know something about. Obviously, in a bill such as this, a number of objectives get brought to the table.
I don't want to be evasive, but I can tell you that in the years of experience I've had advising governments on divestitures, we have always been diligent in keeping the focus of our advice to the financial issues, in effect, to bring to our clients the views of the marketplace.
I believe the financial issues have been dealt with properly, in such a way that we don't believe investors will look at them and penalize the government and the company in terms of valuation. When you look at the ownership limitations, had they been more severe, for example, a penalty might accrue. Had there been restrictions on the company's business, the valuation might suffer. From a financial point of view, I don't think anything can be added that would help.
It's hard to know if decreasing some of these limitations would help the valuation. I don't think it would materially.
I can't comment on some of the other objectives that concern the government on behalf of the taxpayers for placing some of the limitations on there. I can't really comment on whether adding other clauses with the objective of meeting other needs would be beneficial. However, what I can say is that, to the extent this committee has concerns - which I am sure it does - that the clauses will jeopardize the success of the offering, I think I've gone to some length in saying they fit into the norms of other transactions, which is the way investors will look at things. Their ears will perk up if they look at something and find it's different from what they've seen before.
As I said at the outset, this bill covers ground that has been covered before, and from a financial point of view it will be met with acceptance by investors.
[Translation]
Mr. Guimond: What criteria should the government use in selling the assets other than the railway? What criteria should it use in selling the CN Tower, for example? How much do you think it's worth?
[English]
The Chairman: Get the most you can for it.
Mr. Woods: Here, again, the government, like any owner of assets, has to decide how important an asset it is to maintain. I can't address that issue, but the approach you would have to take, particularly in a real estate market that is volatile, is to assess just how important it is to have an asset sale that proceeds quickly versus weighing the advantages of waiting.
The one specific thing I can say is, to the extent the government or any owner of real estate assets felt it had to move quickly, the market, particularly the market we have now, is not going to pay, in our opinion, the value that a more methodical timetable would allow.
The criteria would be that you do an expected-value calculation for perhaps two or three different timetables of asset divestitures and then make a decision as to how important it is to divest the assets sooner rather than later.
The Chairman: To his credit, the minister also indicated that he wasn't interested in any kind of a fire sale on those kinds of assets.
Mr. Gouk: There are so many areas that I don't know where to start. I'll start with where you ended up, Mr. Chairman.
.1930
With regard to a fire sale, if all the real estate assets were of a similar nature in a similar area and you tried to dump them all, that would be a fire sale. But given that some are office towers, hotels, or real estate, are they not divergent enough that in at least most cases putting those things on the market would not be considered a fire sale?
Mr. Woods: It's true that they are a diverse collection of assets. However, I think a fire sale is a matter of degree. To the extent that potential purchasers felt the vendor was very keen to proceed with a sale on all fronts, you'd have to assume that would affect their negotiating position. So perhaps it's one step removed from the hypothetical situation you describe whereby all the assets might be of a similar kind. But if someone came to you and said, ``I have a building to sell you'', and you knew they were selling a number of other assets, you'd react a little bit differently, I assume - I would - than if that were the only building they had to sell and they were pretty laid back about the time within which they were prepared to close the transaction. So it's a matter of degree, but your point is right.
Mr. Gouk: What do you think is the total share value of CN?
Mr. Woods: This is a company that made $245 million in net earnings last year. Time will tell what it will make this year. Certainly the first quarter was a positive one. Until you actually get out and talk to institutions and in effect market the achievements of this company, it's hard to know. However, I think it's fair to say that the value of the government's shares today, putting aside any treasury infusion, should be in excess of $1 billion. I can't be any more precise than that at the moment.
Mr. Gouk: So as the debt structure sits right now, they're worth about $1 billion.
Mr. Woods: No. If this company were brought to market and the debt dealt with in a way that I discussed with you before, our belief is that the characteristics of this company relative to the U.S. firms would be such that the value of the shares the government owns today, putting aside any value the government might receive for real estate that might be transferred, should be in that order of magnitude.
Mr. Gouk: If we were to take the real estate assets of CN and pay down their debt by $1 billion and if we were to do a good job, we might get $1 billion for the company.
Mr. Woods: No. I think what I said was that if the debt is taken care of and if some of the regulatory and labour issues -
Mr. Gouk: You were talking, were you not, about a $1 billion reduction, from $2.5 billion to $1.5 billion?
Mr. Woods: At the moment the book value of the equity of CN is about $2.5 billion. That's right. Now, that's an accounting value, and any company you look at has a book value different from its market value. I think what I'm saying is that our rough estimate at the moment is that at least $1 billion would be the value of the shares the government owns in CN.
Mr. Gouk: So we sell it, and we get $1 billion.
Mr. Woods: Right, plus the value of any real estate or other assets.
Mr. Gouk: So we would keep the retained value of the real estate.
Mr. Woods: Right.
Mr. Gouk: So we reduce it by $1 billion. We would get the $1 billion, and we would have maybe $400 million or $500 million of real estate. So we get about $1.5 billion altogether.
What would happen if we took the assets, didn't reduce the debt at all, and gave it to somebody? Would somebody take it for $1?
Mr. Woods: I don't know how broad your hypothetical situation is. Are you talking about an individual or several individuals?
Mr. Gouk: A company or whatever.
Mr. Woods: Absolutely. Anything that's worth $1 billion -
The Chairman: I'd buy it.
Mr. Gouk: I just want to see if I understand this. We're talking about taking $2.5 billion of debt, paying $1 billion on that, taking the real estate assets, and then trying to sell it for $1 billion to recover the $1 billion we reduced it by, plus still have the real estate assets.
Mr. Woods: You have to look at this in sequence.
Mr. Gouk: Is that what we're doing whether we do it in that sequence or not?
Mr. Woods: No.
Mr. Gouk: Then explain it to me again, because that's what I understood you to say.
Mr. Woods: At the moment you have a company that has $2.5 billion of debt. It has assets consisting of rail assets and non-rail assets. The rail assets could be transferred or sold prior to the offering. If those rail assets were maintained in the company, our opinion is that the public investor wouldn't pay you an incremental value anywhere close to the value you could get -
.1935
Mr. Gouk: I understand that, and I'm not suggesting it's -
Mr. Woods: That's fine, but that's a step along the way. If those assets were transferred to the government for cash, the government would be no further ahead. They would have $500 million of real estate, and they would still have shares in a company that could be divested for, we believe, in the order of $1 billion. So whether you do a Treasury offering or the government puts money in, the company is worth what it's worth, and we believe -
Mr. Gouk: What I'm getting at is if we take the $2.5 billion of debt and buy our own assets back from them - because they are, after all, a government holding - we acquire the real estate and give them credit. Whether we sell it now or later, let's assume we'll get our money. So now they have $2 billion of debt rather than $1.5 billion, which you say is the target. What is the impediment to simply selling that company for $500 million less and not putting another $500 million of the taxpayers' money into that company?
Mr. Woods: The impediment is that we don't believe equity investors will be interested in buying shares in a company whose debt rating is less than investment grade. It's as simple as that. At a price, I guess investors would be prepared to pay something, but it would be viewed as a bit of a distress sale. We're convinced that in this market for this company the company has to have investment-grade debt. So the valuation you would get is not a linear valuation. It would draw quite a bit. That's the rationale behind just having to fix the balance-sheet before the offering proceeds.
Mr. Comuzzi (Thunder Bay - Nipigon): I'm trying to figure out what you're saying.
I always like to know, Mr. Woods, how we have got to the point we're at. When I reviewed CN's balance-sheet, I hadn't realized that CN's credit rating was as good as it was, AA. Is that correct? Why would we have gone out several years ago and issued debentures for huge amounts of American money, repaid in American money, and pay interest rates in excess of 15% U.S. if we had that kind of credit rating?
That wasn't my original question, Mr. Chairman, but that begs an answer. We went out and issued huge amounts, over $100 million, at in excess of 15% - I don't have the financial statements with me - payable in U.S. funds. At 40¢ on the buck today, that's a huge indebtedness. Why would a company do that?
Mr. Woods: CN, obviously like a lot of companies, had a need for funds to repay debt maturing, to make capital expenditures, and to fund losses. The option, I suppose, of not raising that debt would be to cut back its capital expenditure program to get out of some businesses. The fact that it had a very high credit rating, quite frankly, reduced the interest rate it had to pay. You're talking about the early 1980s, when some companies -
Mr. Comuzzi: It was in 1985-86, if my memory serves me correctly.
Mr. Woods: That's where interest rates were, and there was no indication they were going any lower at the time. Some people thought they were going higher. In hindsight, sure, those are very high rates of interest. Some of those bonds were hedged back into Canadian dollars.
.1940
The answer to your question is that the company had a use for the funds. They were obviously borrowing the funds thinking they could invest in assets that would in the future generate earnings, as they in fact did in 1994, and so far have in 1995.
Mr. Comuzzi: All of us around the room are politicians, and we know why there are restrictions on the head office and other things, which really takes away from the value we're going to receive.
I'm a little bit surprised that you would defend that position, inasmuch as you are the scientist in this. All of us are politicians and we go to Wood Gundy and Nesbitt Burns for professional advice. Why would we have restrictions?
Mr. Woods: I think you will have to answer why you need that restriction. I guess I can honestly say that it's so common in divestitures such as that, that if you asked me what percent of the value we are leaving on the table, it's negligible.
In fact, in the case of CN, to the extent that anyone raises it - and I doubt they will - this is a company that, in the case of its head office in the MUC, has a very high amount of business in the province with respect to the Official Languages Act. Obviously, it has customers and suppliers that speak both languages. I doubt it will even come up.
Mr. Comuzzi: Were we not led to believe - and I ask this as a question of fact, rather than making a statement of fact - that the majority of CN's business is from Vancouver to Winnipeg? Or is that wrong?
Mr. Woods: No. It depends on how you measure business.
Mr. Comuzzi: Dollar volume.
Mr. Woods: Yes, dollar volume. At the moment, 60% or more of the dollar volume in the business is cross-border. There's no question that the grain business has been the most profitable business. The intermodal business is the highest growth and, arguably, highest potential business.
Your point is correct: most of the business at the moment, in terms of revenue, has been in western Canada.
Mr. Comuzzi: How do you see the results? How does VIA Rail play in this? We have to use those tracks, either there or CP. I happen to know what CN has received in the way of remuneration on an annual basis from VIA Rail. Is this an asset or a liability with respect to providing rail service on those rails?
Mr. Woods: I must admit that is not an area we got into in a great amount of detail. I'm not quite sure what the specifics of your question are. If your question is to what extent the payments from VIA Rail to CN for the use of CN track help CN, obviously that is factored into the revenue and the earnings. But my recollection is that's not a large percentage of CN's revenue. Was there another angle that you were interested in? Is that it?
Mr. Comuzzi: Oh no. I'm concerned about the future of VIA Rail when CN will be privatized.
Mr. Woods: Oh, I see.
Mr. Comuzzi: Would CP and CN be vying for VIA Rail's business or would they be shying away from it? I'm not sure how this transaction, as it unfolds, affects passenger rail service.
The Chairman: I don't know if it's a question we should be asking Mr. Woods.
Mr. Woods: I think the simple answer is that it's not that material in a narrow financial evaluation of the prospects of CN's earnings. It's obviously very important to VIA Rail.
Mr. Comuzzi: I think it would be very important to them.
Mr. Woods: The impact on CN's value, which is the focus of our analysis, is that it's -
Mr. Comuzzi: VIA Rail is just another customer then.
Mr. Woods: Well, it's an important customer, but when you stack it up against grain, potash and intermodal, it's not significant.
Mrs. Cowling (Dauphin - Swan River): I am a westerner and I'm particularly interested in the grains end of it. My question is a follow up to Joe's, in the response that you had made with respect to revenue that comes out of western Canada through the grains industry. It is my understanding that at least 53% of the volume is grain that moves through the system.
Do you think special efforts should be made to encourage Canadians or those western Canadian grain companies that are farmer-owned to buy CN shares?
.1945
I have another question that relates almost directly to that. We know that CN has considerable overcapacity and a high-cost operating structure. One of the things I'm hearing from my constituents is that we should keep this link of steel from the west to the coast and that it is in CN's interest that it should be national. However, if there are parts of the system that are not cost-effective, then what is your view of keeping this link across the country?
Mr. Woods: You asked two questions. The first is if it would be beneficial to encourage some of the grain customers to buy CN shares. As on the question of employee ownership, if some of the customers of CN were seen to be active investors in the company, as long as it didn't raise questions about the potential for customer influence on the business of the company to the detriment of other passive financial investors, it has to be a good thing.
This is really a question for government, as to whether similar incentives to the employee should be offered to customers. That has been done in a few British divestitures. I don't know that it has been done in Canada, but that would be a cost benefit trade-off the government would have to make. From the standpoint of institutional investors looking at the company and the share offering, frankly, their attitude is the simpler the better, and the fewer bells and whistles the better. If it were within reason, it might be neutral to mildly positive.
In terms of whether parts of the business should be divested if they weren't cost-effective, if you're expecting investors to pay fair value to get the highest price for the shares of CN, then they have to have a comfort level that this company will be free to operate in the same way as any other private sector company would operate. Then if there were areas that they wanted to expand in, they have the flexibility to raise debt to do the expansion. Similarly, if there were areas that weren't pulling their weight, they could either continue operating with some subsidy from the interested parties or be free to abandon them, possibly to short-line operators. It is very important that there be that flexibility.
Mr. Gouk: I would like to try one last aspect in terms of the debt reduction.
If we took $500 million of the taxpayers' money and used it to reduce CN's debt - I'm referring in part to your comment that if CN does not achieve at least a triple-B bond rating, investors would not be prepared to pay full value for CN shares. So if we reduce the debt by $500 million using taxpayers' money, are you fairly comfortable with the idea that we would get $500 million more for the shares?
Mr. Woods: Absolutely.
Mr. Gouk: Would we get more than that?
Mr. Woods: You might get more. The comparison that I think you made a moment ago is what we would get if we tried to sell this company with more than $1.5 billion of debt? The psychological barrier you'd have to face up to in the market would be very large. Any money put in by the government flows back to the government when you actually do the numbers.
Mr. Gouk: It is an interesting concept.
So you think that if we can get their debt down to $1.5 billion, that would make an acceptable bond rating, and that should give us the best opportunity to sell the shares. I realize there are no guarantees.
Mr. Woods: We have been asked at what level this company's debt should be to ensure a bond rating. As I explained a minute ago, it's difficult to be precise. You have to make assumptions on some of the other moving parts. But with some improvement in the regulatory environment, with continued good earnings this year and with continued progress in reducing costs, $1.5 billion of debt produces the kind of interest coverage that we believe will produce a triple-B bond rating.
.1950
Mr. Gouk: Would you see it as a problem, in terms of this legislation that you've commented on at length, if the legislation itself put a limit of $1.5 billion as the amount to which this could be reduced?
Mr. Woods: I do have a problem with that. It has nothing to do with the number, but just the optics to investors of placing this kind of limitation in a bill, because investors will see that as unusual, particularly in a scenario where time passes and things change. I think $1.5 billion is a reasonable amount of money. I think the appearance of having this kind of restriction in a bill does convey to investors that there are more limitations going forward for the company. It's not a major point, but it's an optic point about which I have some concern.
Mr. Gouk: I find it interesting that you think it would be very unusual for the government to be prudent with its money and to put some limitations on it. I have to agree with you on that.
If you took a fancy to my briefcase and I said, ``Fine, I'll sell it to you'', would you be prepared to write me a cheque leaving the amount blank, which I'll fill in later on an account you have that has lots of money in it?
Mr. Woods: No, I certainly wouldn't, but I would perhaps take some comfort if the process by which things such as this normally occur would leave me in a situation where I had a cheque with the amount of money that I had anticipated. The point I'm making - and I suspect your comment was somewhat facetious - is that investors - and as taxpayers - will take some comfort in the process that governments follow in ensuring that prudence will govern.
My point is that, to the extent to which the bill deals with issues that appear to convey some concern or some lack of flexibility, it may raise questions.
Mr. Gouk: When you talk about my trying to represent prudence on the part of the would-be shareholders, I'm more concerned about representing some form of prudence on behalf of the taxpayers, who are going to pay this down.
I'm placed in a position where I have to vote on this. I support the concept of privatization of CN. In fact, I've been yelling for it for some ages now. Mr. Nault knows that well. I was concerned that they wouldn't do it.
What I'm concerned about now is how I can vote for this when I'm told they're going to reduce the debt. We've heard figures bandied about, but I have no assurance that it won't be down to $1 billion instead of $1.5 billion. I have no idea how much the government is going to pay for the assets, whether we are going to pay twice as much as we can ultimately flog them for on the market ourselves, whether we're going to give them an inflated thing. So I am in essence, on behalf of the taxpayers of Canada, being asked to sign a blank cheque for this little thing we think we'd like to do, which is to privatize CN.
This is why I would like to know why you feel that it would be an impediment to put right in the bill that we're going to reduce CN's debt to an amount that you, as a financial expert, are saying should produce a kind of credit rating that would make this viable on the market. This would be an impediment to it, given the fact that I have some responsibility to all the people who aren't buying shares.
Mr. Woods: I understand. I go back to what I said. It might be a minor impediment. I believe the minister is on record at $1.5 billion.
The other point that I think is relevant is that I'm convinced that any dollar that goes in flows out in valuation terms, because the pro forma net income of this company, which is the basis for valuation, gets adjusted upwards.
I understand the nature of your question. From a financial point of view, the valuation impact is positive if more money goes in. From a financial perspective, I'd like to see a bill that appears, to the fairly uninitiated analyst reader, to have relatively few restrictions.
.1955
It's not a major impediment. It might be a minor impediment.
Mr. Hubbard (Miramichi): I want to follow the line of discussion we've just had. You've studied and analysed and probably have some thoughts in terms of what kind of prospectus might be put out on the sale of CN.
I remember that with Air Canada there was a certain issue price per share. I suppose that with CN you would have the same basic thought - $10, $15, or whatever it might be.
How many shares would be issued to cover the value of CN at a certain nominal price per share for offering? Have you thought that through?
Mr. Woods: Quite frankly, I'm not completely up to date on the thinking that the other more recently involved firms have taken in this.
As in the case of Air Canada, the process followed is that the investment banks involved are asked what price per share seemed to have the most marketability. In the case of Air Canada, the group felt, because the government wanted to appeal particularly to individual investors, that a lower dollar number was desirable. That is why $8 per share was picked. As you may know, shares trade in lots of 100, so if someone had as little as $800, they could have bought 100 shares of Air Canada.
Institutions are generally indifferent. Some say that higher share prices have a bit more appeal to institutions, but that's debatable. Quite honestly, the price per share is not a big issue unless you're trying to appeal to individual investors.
To answer your question specifically, depending on the extent, if any, to which Treasury shares were offered, you simply take the valuation that the investment banks believe investors will accept in aggregate terms, in millions or billions of dollars. You ask yourself what share price you want, divide that share price into the aggregate valuation of the company, and you get the number of shares. It would be several hundred millions of shares. But investors really look through that, because it's the aggregate value that matters, not so much the share price.
Mr. Hubbard: In your study, what is this aggregate going to be?
Mr. Woods: When you look forward to 1995, assuming you adjust the debt downwards, a saving of interest payments is created. For a company that made $250 million last year, you would get a company that might make $400 million.
The wrinkle you have to apply, as I take you step by step through this, is that this is a company that won't pay income tax next year because it has credits. It won't pay it for it a few years.
The market-place won't just accept the application of a price-earnings multiple to that $400 million. There'll be some discount.
We think the government's valuation of the shares it owns today would be in the order of $1 billion or higher. That is the number you would be looking at in aggregate as you go forward. You'd simply divide that by the number of shares and you would have the number of shares outstanding.
Mr. Hubbard: Theoretically, you're saying that if Mr. Gouk's questioning is correct, if the government puts $500 million to $1 billion into it, we might get $1 billion back. Is this correct?
Mr. Woods: No. You will get $1 billion or more for the equity of a company that has debt of $1.5 billion. In that example, the government will also have the valuation of the real estate assets, whatever that is. Our estimate is that, depending on -
I can take you through this on a piece of paper, because it's hard to go through this verbally. I can assure you that any money put in by the government enhances the value of the company. That value flows to the government. Investors are naturally going to be prepared to pay more for something if funds have been injected. It really is a linear equation. It's very hard to describe verbally, but I can assure you -
Mr. Hubbard: I want to follow up on the other question about a railway coast to coast. You talked about two limitations, in terms of where the headquarters is to be located and in terms of official languages.
.2000
We also have a constitutional obligation to maintain a railway from Halifax to central Canada. Was that part of your thinking in terms of the study you did for the ministry?
Mr. Woods: I must admit that I'm not fully versed on the constitutional law. The assumption we are working on is that we will have a regulatory environment that will enable CN to operate its business free of any impediments to maintain operations that are uneconomic.
I have to be honest with you. If you're telling me that this constitutional issue may impact on CN or CP to keep open lines that would otherwise be closed, then I'm working under -
Mr. Hubbard: It's not part of your -
Mr. Woods: No.
Mr. Nault: I want to get back to the issue of labour unrest. My understanding, in following the issue of labour relations in the North American railway system, is that our railway labour regime is fairly stable. You could count the times that there's been a strike in Canada in the railway industry in the last 100 years. There have not been many.
When you look at the issue of labour unrest, is it the railway employees themselves, or is it the overall labour regime in Canada per se? For example, when the guys at the elevators go on strike, they don't work on the railway but they shut the railway system down. Is that taken into consideration when you talk about labour unrest, or are you suggesting that the problems in the labour side of things are worse here than they are in the United States, as an example?
Mr. Woods: I must say I'm not completely an expert on the situation in the U.S. It is fair to say that when you read the bond rating agency's assessment of Canada, there is a focus on the terms that have been negotiated in past years to deal with the labour tensions or shutdowns. It's less an issue of the extent to which strikes occur.
Investors will recognize that rail across the country is such a vital issue to the economy that strikes aren't going to last a long time, but the outcome of some of these negotiations to investors, in terms of things such as employee security, probably have a larger negative impact than they really should have economically. There's an impression or perception that one has to deal with here. It's probably that more than it is relative strikes in terms of the impact on value.
Mr. Comuzzi: I have a point of clarification coming out of Charlie's questions.
When this was first proposed, Mr. Woods, some of us did the arithmetic and we thought that, in order to make this share offering attractive at $1.5 billion, the taxpayers would have to come to the party for about $500 million. If I'm listening to you correctly tonight - please tell me if I'm wrong - in the information you've given to Mr. Hubbard and Mr. Gouk, I'm doing the arithmetic now and I'm hearing - and forget about shareholders - a number that sounds close to $1 billion to $1.2 billion. Please tell me I'm wrong.
I'm going to try to define that question. The obligation of the taxpayers of Canada, in order to privatize CN, will be in the neighbourhood of $1 billion to $1.2 billion.
Mr. Woods: That is not the proper way in which to look at it. I'll try -
Mr. Comuzzi: Tell me what the proper way in which to look at it is, because I'm not understanding what you're saying.
Mr. Woods: It is a difficult concept. Perhaps you'll indulge me to use a simple analogy.
Let's suppose you had a house and it had a kitchen that really wasn't up to par. You wanted to sell that house. You know what you think that house is worth. If you want to extend the analogy completely, maybe it has a bit of a mortgage on it, but let's just -
.2005
Mr. Comuzzi: Stay with fixing the kitchen in the house.
Mr. Woods: You say to yourself, ``Should I sell the house and get $100,000 for the house with a poor kitchen, or should I put $20,000 or $50,000 into the kitchen and, one, be assured that that house is going to sell and, two, get more money incrementally than what I put into that kitchen.
The reason why this is a difficult concept to understand is -
Mr. Comuzzi: I'm with you so far.
Mr. Woods: - that when you look at a company that has a very high amount of debt - and let's take the extreme case where the government or a company that has a subsidiary says to itself, ``Why don't we just sell this company to investors'' - investors, in our opinion, will not buy shares of a company that has too much debt. That's perhaps too definitive a statement, but I think it applies in the case of CN because of the very high concern they will have about this company's ability to raise financing next year or the year after.
If this was a very small company that had to raise a very small amount of money, it may not be a problem; but, as everyone knows, this is the largest contemplated equity issue by any company in Canada ever.
So we're saying you've got a company that we don't think could be sold until the capital structure is dealt with. The taxpayers, represented by members, have the option of injecting money into the company to try to achieve an aggregate valuation at the end of the day that will be higher than would be the case otherwise.
What I've said to you is that, at the end of the day, this share value might be in the order of $1.5 billion, in very round numbers, including the real estate. I think when you actually do the analysis and you compare it to what the proceeds would be without fixing the debt, they would be much lower.
Mr. Comuzzi: This question isn't fully answered, Mr. Chairman, with great respect.
So what you're saying is that we have to inject around $1 billion in order to get the debt down.
Mr. Woods: Either you or investors in Treasury shares have to inject $1 billion. Either way, the debt has to be reduced from $2.5 billion to $1.5 billion, roughly.
Mr. Nault: The equity in real estate is $500 million dollars.
Mr. Woods: Roughly, that's right.
Mr. Nault: So we're going to inject only $500 million to get a $2-billion return.
Mr. Woods: That's right. If you follow the route of injecting, that's right; it's $500 million.
The Chairman: For any further clarification on that, Joe, maybe you could speak to Mr. Woods after the meeting.
Mr. Gouk: If I could have a little bit of licence for just one comment, I'm glad you got into the real estate analogy.
Using a $100,000 house, if you put $5,000 into that kitchen you might get $110,000, but I can tell you right now that if you put $50,000 in that kitchen, you would not get $150,000 or $160,000. That's the concern I have with what we're doing on CN.
As I'm going to have some limit tonight, I have quite a number of questions yet, some of which will have to go unanswered.
The area I'm concerned about at this time is the 15% limitation. In your book, you talk about the fact that you don't feel it will cause any problems, all in all, to limit it to that. So we're not doing it because it's a positive thing; we're doing it because it's not a negative thing.
You refer to other Canadian companies at the time of initial public offering. When you talk in terms of ``initial'', are you talking strictly from the point of view that it's offered for the first time or that initially those restrictions were placed on it to be removed later, such as Air Canada and Petro-Canada?
Mr. Woods: Both. That table listed the individual ownership restrictions at the time of the initial public offering. That was the initial limitation at the time the company sold shares to the public at the outset.
Since that time, as it happens, two companies have removed those restrictions: Alberta Energy and Potash Corporation of Saskatchewan. Air Canada and Petro-Canada still have those limitations on. So there would be nothing to say that at some point in the future, after any concerns or objectives the government had to have those restrictions in place had since passed, they couldn't be removed.
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Mr. Gouk: That wouldn't be a detriment?
Mr. Woods: Would it be a detriment to remove them?
Mr. Gouk: Yes.
Mr. Woods: No. It might be a slight positive at the time, only because of optics. Now, is the reverse true: is having them on today a negative? It's not a positive. It's very common and probably not an impediment.
Mr. Gouk: On that positive note I will end.
The Chairman: Mr. Woods, thank you very much for your very thorough submission, the knowledge-based answers and professionalism in answering our questions. We appreciate the time you've taken to be here.
Mr. Gouk, just for your information, you say that a number of your questions will go unanswered, but tomorrow we'll also have three additional underwriters here whom you could probably address.
Mr. Gouk: I recognize the time limitations.
The Chairman: We have limitations. Our witness has been here since 6:30 p.m. and it's now 8:10 p.m.
Mr. Gouk: I recognize that. I'm here too.
Before you hit your hammer, are we going to deal with my question?
The Chairman: Mr. Gouk has a question to ask of us.
Mr. Gouk: I am referring to the main estimates for Transport for the fiscal year that we're into now. I always somehow had the impression that it would ultimately come back to committee to be dealt with. Now I understand that if we don't specifically ask to deal with it, it's deemed to be accepted.
I have some motions that I would like to make on it. As this has to be done by Wednesday, I would like to bring these motions before you on the agenda at our next meeting, which is tomorrow.
The Chairman: All right, we'll put them on the agenda for the next meeting, which will be tomorrow, and we'll vote on those motions accordingly.
Also, colleagues, I'll request that we get as many answers as we can through the different witnesses we have lined up for this week. I appreciate the efficiency with which we're working to complete the bill.
We hoped that if you had any amendments.... I understand that Mr. Gouk has already prepared his. Oh, there they are, great.
Mr. Gouk: Perhaps either you or the clerk can answer this question. I've got a confirmed agenda for tomorrow. I understand that we're meeting on Wednesday, but I don't have it confirmed, and that we're tentatively planning to go to clause-by-clause consideration on Thursday.
The Chairman: After witnesses on Thursday.
The Clerk of the Committee: Mr. Gouk, the notice for Wednesday was sent out on Friday.
Mr. Gouk: Was it?
The Clerk: Yes, it was.
Mr. Gouk: Okay.
The Clerk: It's in everybody's office. And the notice for Thursday went out today.
Mr. Gouk: Good enough.
The Chairman: So there is an agenda with the witnesses all firmed up.
If we can have the amendments in, then we can deal with them when we go through clause by clause on Thursday.
Mr. Gouk: I am waiting for one last amendment in translation. I don't have a big list.
The Chairman: I hope not, in 21 clauses. We don't want too many.
This meeting stands adjourned.