Why I sold Aeroplan

I was one of the fortunate ones. I was able to get a respectable allotment of Aeroplan shares from my brokers at the IPO (initial public offering) price of $10.

I hadn’t even received the shares before I sold them all when they started trading on the Toronto Stock Exchange on an “if, as, and when issued” basis. That’s out of character; I rarely do quick flips. But if someone wants to pay me a premium price for an asset I have owned only a few days, I have to think long and hard about it. In this case, I chose to let the shares go. Here’s why.

When the Confidential Information Memorandum outlining the terms of the offering was distributed to the financial community in early June, it projected an initial cash-on-cash yield of 7.5 per cent to 8.5 per cent. Obviously, both Aeroplan management and the underwriters felt this was a fair and reasonable return for the risks involved.

These documents are supposedly for internal use only by brokers and institutional investors, but that’s nothing more than a convenient fiction. Brokers use this information to promote new issues to clients and the media inevitably gets hold of the key details. In this case, the high prile of Aeroplan ensured that the anticipated return received wide coverage.

That helped to fuel demand for what was already destined to be a hot issue. Brokers were overwhelmed with orders and eventually had to ration their allotments carefully, with only top-level retail clients getting a piece of the action.

Shortly before the issue was formally priced, Aeroplan and the underwriters decided to take advantage of this situation to raise the ante and pocket more cash for themselves. They announced that the actual cash-on-cash yield would be even lower than the bottom of the originally projected range, coming in at between 7 per cent and 7.25 per cent. In the end, the 7 per cent figure was chosen – big surprise!

Raises ethical questions
This is not the first time this sort of thing has happened, but it raises some serious ethical questions in my mind. Investors placed their orders in good faith on the basis of information that had been provided to them by the underwriters. Yes, they had the option of cancelling once the actual pricing was announced but given the high demand it’s likely that few people actually did so. All this has a faint whiff of bait-and-switch about it and our securities regulators should take a close look at such practices.

Despite the greatly reduced yield, the shares took off from the moment they started trading on the TSX (the symbol is AER.UN). On June 23, the first day they were listed, more than 12.6 million shares changed hands as investors who had been shut out of the IPO rushed to take a position while some of those who had been fortunate enough to get in at $10 took quick profits. The price touched $11.93 that day before settling at $11.81.

Every day since then has seen lower volume. This suggests that the institutional investors are sitting on the sidelines and that the buyers at this stage are primarily retail investors who still want to get in the door.

The shares closed on June 30 at $11.80 and traded as high as $11.95. At these levels, I believe Aeroplan is just too expensive, at least on the basis of what we know at this time.

At $11.80, the shares are yielding 5.9 per cent. By comparison, Yellow Pages Income Fund (TSX: YLO.UN) is yielding 6.4 per cent and RioCan REIT (TSX: REI.UN) is yielding 6.3 per cent. A top-notch closed-end fund such as Citadel Diversified Income Trust (TSX: CTD.UN) is yielding 8.3 per cent. These are all proven entities with well-established distribution records. It makes no sense to me that a newcomer like Aeroplan should be trading at a significant premium to all of them. Yes, I like Aeroplan and I believe it has growth potential. But investors are already pricing in that future growth, long before we have any reason to believe it will actually happen.

That’s why I sold. When a security becomes too rich, it is time to take profits and move along. Let someone else assume the risk of buying in at these levels.