What Bell Canada Executives are Telling Me

A very good friend of mine is a director at Bell Canada’s wireline acquisition marketing department. He is also an MBA graduate and a CFA Charterholder, which is why I love to pick his brain. This time around, the topic at hand was very close to home for him — BCE Inc.’s potential takeover by private equity firm, Kohlberg Kravis Roberts & Co.

Executives of public companies usually fear merger and acquisition transactions. In a typical shuffle, heads, particularly those that stick out the most, almost always roll. But, my friend is uneasy about this potential takeover for other reasons as well. If KKR pulls off its proposed leveraged buyout of BCE Inc., the transaction would effectively take Canada’s darling public company private. Since most Canadians own at least a couple hundred shares of BCE Inc. in their portfolios, it would be a huge loss to have another great company disappear from our equity landscapes.

On the other hand, this is just another sign that telecom bellwethers, such as BCE Inc., are in dire need of reinvention as cable companies invade the telecommunications market like locusts. What BCE Inc. believes is an ace up its sleeve is a potential merger with Telus Corp. But the two already tried this trick about year ago, alas, to no avail. Although, this time, Telus might be more interested, considering it too had to fend off a buyout offer or two since then.

Succumbing to KKR pressures and going private after decades of being a public company would be bad enough for BCE. But, a merger with Telus may also place BCE at a disadvantage, limiting its negotiating power. In any merger or buyout, free cash flow is the key ingredient. In the case of Telus, its cash flow increased from $845.0 million in 2003 to $1.6 billion in 2006. That said, BCE’s cash flow dropped from $2.0 billion in 2004 to $1.9 billion last year. Not much maneuvering space there.

Bay Street is actively speculating that a merger with Telus, rather than KKR’s buyout, will be the route to take. Among other reasons, analysts mention that KKR doesn’t like hostile takeovers and that shareholders are more likely to go for an attractive merger combination of BCE and Telus. What the Street is thinking is evidenced in hedge funds putting buying pressures on both stocks, resulting in recent price appreciation.

What is last week’s biggest story telling investors? Well, everyone knows that potential takeover or merger targets appreciate in price immediately preceding the event, particularly when still at a rumor stage. That’s a no brainer for experienced speculators. But what is more interesting, and not necessarily in a good way, is the fact that Canadian markets are becoming like magnets for foreign takeovers.

On one hand, takeover targets run up in price in the short term, resulting, at times, in obscene profits for investors. The flip side of that coin is that these profits are also a one-time thing, never to repeat again with that particular stock. In addition, one by one, Canada is losing the head offices of truly great companies.

The ripple effect is that Canada’s stock markets are becoming more and more marginalized, which I find a worrisome trend. A way out? It would have to be twofold: Canadian companies need to be more adaptable, more flexible, and more attractive to their own shareholders, and both industry and government must implement more regulatory controls and breaks without impeding normal economic processes.