Friday, July 11, 2008

BCE will be the world’s largest leveraged buyout.....and what, that’s a good thing?

Presently BCE is Canada’s most widely held public company with 600,000 shareholders, $34 billion in equity and an investment grade credit.

Soon it will be a private company held by four private equity firms (3 of them US). $8 billion in equity and a junk bond credit rating.

News headlines would have us believe that this is a great and wonderful thing.

The pie chart above from Teachers’ website shows what's going on here. BCE is loading itself up with $34 billion in new debt (in addition to the $12 billion of existing debt), such that BCE’s equity value is reduced to $8 billion, and Teachers’ will invest $4 billion to own 50%.....of a $52 billion market cap company.

BCE also just happens to be Canada’s largest telecommunications carrier and the sector is rapidly changing and highly capital intensive in nature. The cost of capital of a phone carrier is the single most important determining factor in determining how competitive a phone carrier will be in terms of the costs of its services and its ability to roll out new services into the marketplace. As the largest phone carrier, any change in the cost competitiveness of BCE will affect how other players in the market respond.

It is inconceivable that the leveraged buyout of BCE will lead to any outcome other than (1) the partial or complete dismantling of the company as we know it and/or (2) a dramatic increase in the cost of service and/or diminution in the roll out of new technologies. Moving from an investment grade credit issuer to a junk bond issuer will add some 240 basis points (2.4%) to the cost of BCE’s debt capital, at time when interest rates are single digits. Debt will constitute 85% of BCE’s new balance sheet. Meanwhile the new equity owners of BCE have some of the highest return expectations in the investing world, and seek returns in the 30 – 35% level, adding to the overall cost of BCE’s capital.

Why is Canada the only country whose legacy telecom carrier has gone private by way of a leveraged buyout? To do so required government approval. Meanwhile filings made under the access to information act have confirmed that Industry Canada performed “no studies or net benefits test” to ascertain the likely impact on consumers and the government’s lessened tax collection from an LBO of BCE. The government has explicitly endorsed this deal, making Canada an “outlier” in terms of the global telecom industry.

How much of an outlier can easily be determined by looking at the capital structure of other telecom companies around the world, and their respective debt to equity ratios. For example Vodafone has $0.36 of debt for every $1.00 of equity.

By comparison BCE will become a complete outlier with $5.50 of debt for every $1.00 of equity, as follows:

0.36 Vodafone Group
0.43 Sprint Nextel Corporation
0.51 Turkcell Iletisim Hizmetleri A.S.
0.61 Mobile TeleSystems OJSC
0.64 Nippon Telegraph & Telephone
0.79 Telefonaktiebolaget LM Ericsson
0.81 Deutsche Telekom AG
1.10 Vimpel-Communications
1.31 TELUS Corporation
1.67 Telekom Austria AG
1.67 PT Telekomunikasi Indonesia
1.68 Telecom Italia S.p.A.
1.68 Telenor ASA
1.69 France Telecom
1.75 China Netcom Group Corp (HK) Ltd
1.77 BCE Inc. (pre-LBO)
2.01 Telstra Corporation Limited
2.03 BT Group plc
2.35 Rogers Communications Inc.
2.43 Telecom Italia S.p.A.
2.51 Swisscom AG
2.65 Hellenic Telecommunications S.A.
2.73 Telefonica S.A.
3.18 Koninklijke KPN N.V.
3.23 Portugal Telecom, SGPS
5.50 BCE (post-LBO)

Lest there be any doubt about the impact of the cost of capital to the cost to consumers, the following excerpt is from a April 2003 Report by Parliament's Standing Committee on Industry, Science and Technology:

“A higher cost of capital slows the rate of capital investment and, in turn, the roll out of competitive services

A cost of capital differential of approximately 1.18% exists between Canada’s incumbent telephone carriers and Canadian cable companies. This incremental cost equates to about $1.46 per month per cable subscriber.”

As such the debt leveraged buyout of BCE by private equity defies two policy objectives of the Telecommunications Act (see below), one pertaining to efficiency and one relating to ownership as follows, an yet this LBO of BCE was approved by Industry Minister Jim Prentice with no Industry Canada studies or net benefits tests (as acknowledged ed by Industry Canada):

Telecommunications Act: An Act respecting telecommunications 1993, c. 38

Canadian Telecommunications Policy

7. It is hereby affirmed that telecommunications performs an essential role in the maintenance of Canada’s identity and sovereignty and that the Canadian telecommunications policy has as its objectives

(c) to enhance the efficiency and competitiveness, at the national and international levels, of Canadian telecommunications;

(d) to promote the ownership and control of Canadian carriers by Canadians;

1 comment:

Dr Mike said...

The 2 JIm`s---maybe we could call them the Laurel & Hardy of the financial world.

Which one is the funny one??

If anyone can figure that one out , please let me know because no-one is laughing.

Dr Mike Popovich