This article was originally published in Maclean's Magazine on July 9, 2007
In the future, when investors and consumers ask themselves when everything changed in the telecommunications industry in Canada, they'll invariably look back on this last week of June. That's when Telus Corp. backed out of negotiations to merge with its biggest rival, BCE Inc., which owns Bell Canada, thereby setting off a long series of falling dominoes that seems sure to reshape the entire industry.
It now seems almost certain that BCE will be bought by a consortium of private Canadian pension managers and American private equity investors - its worst parts shut down, the best parts dismantled and sold to the highest bidders. The loss of one of Canada's largest and oldest public companies will accelerate attempts to have foreign ownership restrictions lifted, inviting in not only foreign investors but foreign competitors too. Analysts also anticipate the arrival of a new homegrown national wireless operator to battle big players Rogers, Bell and Telus. "We could go way back in history and there's never been anything like this," says Lawrence Surtees, vice-president of communications research at IDC Canada.
It was only last week that BCE, Canada's largest communications company with sales of $17.7 billion in 2006, had four diverse and attractive bidders vying to buy it for at least $32 billion - making it the largest takeover in the country's history. The Ontario Teachers Pension Plan and Canada Pension Plan Investment Board were counting on U.S. private equity firms like Cerberus Capital Management LP and Kohlberg Kravis Roberts & Co. to raise enough money to make the winning purchase. There were estimates of a Telus offer as high as $46 a share (or $36.6 billion) - a huge premium considering BCE's stock began the year trading around $30.
But only hours before the June 26 bid deadline, CPP announced that two of its financial partners, Onex Corp., and Caisse de dépôt de Québec, were backing out because they were frustrated with the negotiating process. BCE management interfered with its four-member special committee, which was set up to make a deal with bidders alone, according to media reports. CPP was out. Telus quickly followed suit with a concise press release: "The inadequacies of BCE's bid process did not make it possible for Telus to submit an offer."
"That's a hell of a damning statement," says Surtees, who says it signals a lack of trust between Telus and BCE during negotiations. He says a Bell insider informed him that talks have been rocky ever since May 15, when Telus first approached BCE about combining businesses. According to sources within the company, whenever Telus requested access to BCE documents and financial reports - standard operating procedure during merger and acquisition negotiations - BCE would insist on seeing Telus's financial data too. "If that's the case, and that's been going on for weeks, I'd be p-oed too," says Surtees.
So now only two bidders are left standing, Teachers, which is backed by New York private equity firm KKR, and Cerberus, which is partnered with Canadian investor Richard Li (the son of Hong Kong billionaire Li Ka Shing) and the Hospitals of Ontario Pension Plan. CanWest Global Communications and Shaw Communications are also rumoured to be backing the Cerberus bid.
Analysts are split on who will wind up with BCE, if either. On the one hand, Teachers has ties to BCE - it's currently the company's biggest shareholder, and Thomas O'Neill, who sits on the special committee overseeing the sale, was a director of the pension plan until last April. But BCE may prefer Cerberus, since the pension fund has been vocal about its displeasure with BCE's management, especially CEO Michael Sabia.
Whichever group wins, the outcome will bring about sweeping changes to the industry. "These bidders are not in it for the long term. They want to load up the balance sheet with debt, and from there they'll do what is expected of them, which is cut costs to the bone," says analyst Kevin Restivo of the Seaboard Group in Toronto. Analysts expect the new owners will break up the BCE conglomerate, selling off various investments, subsidiaries, and likely making Bell Mobility into a separate company - all with an eye to the ultimate goal: make money and get out. Neither Teachers nor Cerberus is positioned to run BCE as a telephone company for another 120 years, say analysts, and that unequivocally signals the end of Bell's familiar and iconic reign across the country.
With BCE bought up by one of these bidders, Vancouver-based Telus, which saw revenue of $8.8 billion last year and boasts 5.1 million wireless subscribers, would remain the second-biggest player in the Canadian industry. It dominates the wireless market in British Columbia and Alberta, with 45 per cent and 59 per cent of the market respectively, according to a recent report by analyst Jeffrey Fan of UBS Securities Canada. While a merger with BCE would have accelerated Telus's expansion across Canada, particularly in the Ontario and Quebec markets where Bell Mobility and Rogers Communications (which owns this magazine) hold roughly 80 per cent of market share in each province, it is still positioned well for the future. "Telus has strong growth prospects ahead," says Restivo, adding that it could buy Bell Mobility down the road if one of the private equity firms does decide to sell that part of BCE.
Many analysts also foresee new entrants into the wireless market, especially now that the federal government is preparing to auction more wireless spectrum - the publicly administered radio frequency waves on which telecommunication operates. While Industry Minister Maxime Bernier is supposed to announce the rules this fall, most analysts expect the government to "set aside" spectrum to encourage the emergence of a fourth national competitor offering cellphone service to rival Bell, Telus and Rogers. "Telus and Bell have been hoarding the spectrum," say Eamon Hoey, a senior partner at Hoey Associates in Toronto. And that's prevented smaller start-ups from succeeding, he claims. "Without that, you can't provide the service."
It isn't entirely clear who would dare to go it alone against the big three, considering their dominant position in the market. "There's a practical question," says Surtees. "Can a newcomer buck that trend and be viable?"
But since early May, an impressive consortium of smaller wireless companies has been acting as an advocacy group for Ottawa to specifically reserve a block of spectrum for a new entrant. The upstarts include Videotron Ltd., which is owned by Quebecor, and has already indicated that it will buy spectrum no matter what happens with BCE or the set-aside proposal. MTS Allstream, a former BCE affiliate, controls more than 58 per cent of the cellphone market in Manitoba and boasts a stronghold on the business services market there, but has no presence elsewhere in Canada. The third company is Mipps Co., a small private operator owned by Primus Canada, targeting the consumer market. Together, these three are "a potential newcomer," says Surtees, before quickly warning that "It'll be an uphill slog."
Restivo says that other Canadian companies could come forward, including EastLink in the Maritimes, as well as Shaw and Cogeco, which have prospered primarily as cable and Internet providers, but may be enticed into the lucrative wireless business. "You can't view this deal in isolation," he says, predicting a BCE takeover will be the catalyst for more industry-wide changes. "There may be other dominoes to fall. If this deal comes to pass there's more incentive to lift foreign ownership restrictions."
And that may be the biggest change of all. As it stands, foreigners can own no more than 46.7 per cent of a Canadian telecommunications company. This law, implemented during the Cold War era when "economic nationalism coupled with the perceived importance of telephone networks to sovereignty," says Surtees, was the prevailing view. But today, the restrictions are seen as irrelevant and barriers to competition by industry observers. "[They're] so archaic it's absurd," says Hoey. "If I applied foreign investment rules to the oil patch in Alberta there wouldn't be a drop of oil produced. That's the story. How do we create more vibrant competition?" Getting rid of these rules would bring foreign companies to Canada "in a heartbeat," says Hoey. There's speculation that American giants such as Verizon and AT&T, or even European juggernauts like Germany's T-Mobile, the U.K.'s Vodafone, or France's Orange, could make moves into the Canadian market.
If BCE is bought up by one of the U.S. private equity firms, many analysts insist it will be the catalyst for government to abandon foreign ownership rules sooner rather than later. Surtees believes that with only Teachers and Cerberus bidding now, the matter becomes even more pressing.
Once you allow a private U.S. firm like Cerberus or KKR to take the lead in buying and restructuring a Canadian company like BCE, analysts argue, there is no longer any reasonable basis to limit foreign participation in the industry. The issue of foreign ownership and investment limits "is more important than ever," Surtees says.
Of course, there is another possible scenario in all of this: Telus could still be in the running to take over BCE. Restivo finds it hard to believe that such a strategically adroit company as Telus would change its mind about a bid literally overnight. He believes there will be enormous pressure on BCE to grant concessions and invite Telus and other potential bidders back in. If that happens, a deal to create an all-Canadian telecom powerhouse could come together yet. "Telus and CPP are still interested, absolutely. They've got savvy negotiators on their side, and they're not going to move forward unless they have what they want," says Restivo. "There's a huge stare-down happening right now. It's brilliant. Telus has shown Bell today that it sees a future without it, and that puts Bell's back against the wall," he says.
Already, shareholders are beginning to ask whether BCE is really getting the best deal for them. "BCE has to explain this situation to the Ontario Securities Commission, the SEC and the TSX," says Surtees. The whole point of an auction for acquisition is to bring in the most offers at the highest price, and BCE has apparently just run two bidders out of the boardroom. "I'm sure BCE is now seriously contemplating its next moves," Restivo says. "Things have not gone according to plan - they've gone from an ideal scenario of four bidders to treacherous territory, and they're in jeopardy of losing bids."
Never before have so many possibilities - new competitors, a foreign invasion, the breakup of an institution - been in the air at once. "Going forward," says Surtees, "the biggest question besides 'Who gets Bell?' is 'But then what?' " For now, only one thing is clear: it's the end of Canada's phone business as we know it.
Maclean's July 9, 2007