The quasi-auction of BCE to private equity consortia in June 2007 was a direct consequence of the undervaluation of BCE that occurred as the immediate aftermath of Jim Flaherty’s denying BCE from carrying through with its announced intention to convert to an income trust and Stephen Harper’s reversal of his solemn election promise to never “raid seniors’ nest eggs” by taxing income trusts.
One person’s adversity is another person’s opportunity, and there are many interests that are well aligned to exploit the opportunity presented by BCE’s resultant undervaluation. TD bank is one of them. At least that was the plan.
As a result of the proposed highly debt leveraged buyout of BCE, by a group consisting of Ontario Teachers’, and US investors Providence, Madison Dearborn and Merrill Lynch, Canada’s largest telecommunications carrier will go from being Canada’s most widely held company to the private preserve of four institutions, three of them foreign. Such an outcome flies in the face of the Telecommunications Act whose goal is “to promote the ownership and control of Canadian [telecom] carriers by Canadians.”
Meanwhile here’s what proud new US investor Providence had to sat about their new catch of the day:
"This is a unique opportunity to contribute to and participate in the growth of one of the world's most significant communications companies," said Jonathan M. Nelson, Chief Executive Officer of Providence Equity Partners.”
I don’t suppose that comment will form part of BCE’s presentation when they go before the CRTC on February 25, 2008 to seek approval for this sale, since the CRTC’s role is to uphold the legislated goals of the Telecommunications Act. Providence will own 32% of BCE, Madison Dearborn 9% and Merrill Lynch an unspecified lesser amount.
The other adverse outcome of the leveraged buyout of BCE is that the $34.8 billion purchase price for the equity of BCE is being funded with a mere $6.7 in equity and the remaining $28.1 billion is borrowed money. This borrowed money comes from the company itself and not from the equity purchasers, hence the name leveraged buyout. As such the $28.1 billion in new debt used to fund the leveraged buyout will be in addition to the already $10 billion in outstanding debt. As such, these new buyers are purchasing a $52 billion acquisition wih less than $7 billion of cash.
As a consequence BCE will go from being an investment grade credit borrower that had complete access to the equity markets to one whose debt will be rated as junk bond status and with no access to public equity markets. It’s no wonder the bondholders are suing, since such an outcome was never foreseeable in their wildest dreams. This outcome is also counter to the other policy objective of the Telecommunications Act which is “to promote the efficiency and competitiveness of Canadian telecommunications”.
Given the capital intensive nature and rapid technological changes in telecommunications that will be a difficult objective for the privatized BCE to fulfill, given its new high cost of capital that it will be burdened with both in terms of the high cost of equity capital and the exceedingly high return thresholds of private equity and the burdensome cost of BCE’s sub prime debt ratings otherwise known as junk bonds. Meanwhile an alternative exists known as the Catalyst Proposal that averts all of these negative outcomes. Catalyst intends to intervene before the CRTC to acquaint them with the choice that is available to BCE as the country’s largest telecom carrier.
In order to be successful in bringing together this leveraged buyout, the leveraged buyout consortium needed two things in the immediate term Shareholder approval and a syndicate of lenders to provide the $28.1 billion leveraged buyout loan. To achive the latter, the Teacher’s consortium turned to a group of 50 banks led by Citibank, Deutshe Bank and Royal bank of Scotland. Of these 50 banks, TD Bank was unique in that it was both a shareholder of the company to be acquired and a lender to the group who was acquiring BCE. Furthermore TD Bank wasn’t just simply a garden variety lender to the buying group, it was what is known as a bridge equity lender, which carried with it risks and rewards that were greater and which were exclusively tied to approval by BCE shareholders of which it is one.
In fact TD Bank’s TD Asset Management is the second largest shareholder of BCE with 46 million shares, next only to Teachers’ who owns 50 million shares. However unlike Teachers’, TD Bank is not the beneficial owner of these 46 million shares that are registered in its name. Nor are TD Asset Management’s clients’ the beneficial owners of these shares. In fact a very large portion of these shares are shares that are held passively by TD Bank as part of an TSX index portfolio that it is the custodian of and in which BCE is one of the most heavily indexed wighted stocks. Meanwhile it still gets to vote these shares, as if they were the owner. That's hardly kosher.
So the question then becomes, is it merely coincidence or a conflict of interest that TD bank is reported to be the only Canadian Bank amongst a syndicate of 50 banks and certainly the only Canadian Bank with the lucrative and yet high risk role bridge equity provider, whose very risk and reward is determined by the outcome of a successful shareholders’ vote. At the very least, TD Bank should have dealt with this conflict of interest and/or perceived conflict of interest by asking that the shares that they hold passively as part of a passive index portfolio be excluded from the vote tally for purposes of approving a deal, whose outcome affected them in a significant collateral way, namely as a bridge equity provider.
Thursday, January 24, 2008
Posted by Fillibluster at 3:51 PM