The Biggest LBO Ever

Once upon a time, BCE (NYSE: BCE, TSX: BCE) reluctantly assumed the lead role in the largest potential income trust conversion ever. Now, in a demonstration of ubiquity redolent of Woody Allen’s Zelig, it’s the star of the biggest potential leveraged buyout (LBO) in history.

In December 2005, responding to a shareholder proposal to consider conversion, BCE CEO Michael Sabia said the trust format wouldn’t serve the best interests of the company, citing competition, the pace of technological change and the capital intensity of the telecommunications business.

But on Sept. 11, 2006, chief rival Telus Corp (NYSE: TU, TSX: T) declared it would turn into an income trust. A month later, on Oct. 11, 2006, BCE announced its intention to convert into an income trust. BCE essentially admitted it had no choice in the wake of Telus’ announcement, noting at the time that Bell Canada Income Fund “is designed to create value for shareholders through increased cash distributions and to ensure there will continue to be competitive parity in the capital markets within the telecom sector.”

BCE as an income trust–much like BCE, the company–wasn’t as compelling an investment story as a Telus trust. Bell Canada, the company’s operating arm, had been (and still is) losing traditional residential customers to cable firms offering Internet phone service at a fast rate, and it lagged (and still is) in wireless phone service.

Those questions became moot on Oct. 31, 2006.

Sabia’s efforts to “maximize shareholder value,” crystallized in a strategic review announced April 17, 2007, turned to a potential merger with Telus. Those discussions died June 27, 2007, when Telus executives withdrew from the BCE bidding, citing “inadequacies of BCE’s bid process.”

A couple days later, BCE accepted a CAD42.75-per-share, all-cash bid from Teachers’ Private Capital, the Ontario Teachers’ Pension Plan’s private investment firm, and US-based private equity firms Providence Partners, Madison Dearborn Partners and Merrill Lynch Global Private Equity. The offer values BCE at CAD52 billion.

In late May, a Canadian court of appeals ruled that BCE hadn’t properly considered its bondholders’ interests when it accepted the buyout offer. Last week, Canada’s Supreme Court overturned that decision—which could have relieved the bank lenders of their commitments to finance the deal—and said the deal could proceed. Final regulatory approvals came Monday, and now it’s a matter of negotiation.

Now, the four main banks financing the deal—the latest “Biggest LBO in History”—are negotiating to change the terms of the deal in their favor, reported the Financial Times.

The takeover was scheduled to be completed by the end of this month, but the private equity buyers and the banks are locked in “intense” talks over financing terms.  

Reuters reported yesterday that people close to the negotiations have said the banks funding the deal—Citigroup (NYSE: C), Deutsche Bank (NYSE: DB), Royal Bank of Scotland (NYSE: RBS, RBS) and Toronto-Dominion Bank (NYSE: TD, TSX: TD, TD)—have asked for significant financial concessions, including the addition of safeguards on the debt agreements or more lucrative terms on lending the money. The banks also have actively considered walking away from the deal.

A lot’s changed in the 12 months since BCE accepted the CAD42.75-per-share offer, and the banks are pushing for a range of concessions that could make their financing commitments more palatable in a difficult market. Those could involve the rate at which the banks agree to lend, the amount of equity the buyers would invest or lending covenants to which BCE could be subjected.

Three of the four banks—Citigroup, Deutsche Bank and RBS—were involved in the public relations nightmare that became the deal to buy broadcaster Clear Channel Communications (NYSE: CCU). The Clear Channel deal was later renegotiated–at a lower price and with higher interest rates.

Citigroup, Deutsche Bank, RBS and TD issued a statement Friday affirming their interest in completing the deal, but similar statements were made in the Clear Channel transaction.

BCE is still trading well below the CAD42.75-per-share offer, reflecting investor uncertainty whether the deal will be consummated at that price. Canada’s Supreme Court removed one hurdle, but the buyout consortium still must come to terms with the banks providing the CAD32 billion in debt financing.

But those details seem irrelevant in light of the fact that, during 2006 and 2007, Rogers Communications (NYSE: RCI, TSX: RCI.B) added nearly 1.2 million new wireless subscribers, Telus gained 1.05 million and Bell Canada added just 775,000. And the numbers could get worse in the next couple years: Rogers gets to sell Apple’s (NSDQ: AAPL) iPhone, but Telus and Bell Canada can’t. And BCE continues to lose home-phone customers—a growing problem for Telus, too.

The possibilities appear to break down as follows. It’s likely that, if the LBO is consummated, it’ll happen at a lower share price. Should negotiations break down (and skipping over the part about the inevitable lawsuits), a consolidated telecommunications space (once credit conditions settle) may include BCE/Telus redux. And a bolder move, suggested by Dan Fuss of Loomis Sayles Bond Fund, would be for BCE to partner up with a US-based telecom such as Qwest Communications (NYSE: Q).

However it finally plays out, Ontario Teachers’—which holds a 6 percent stake in BCE, the largest position in its CAD108 billion fund—and its backers may look back at the Supreme Court decision as a Pyrrhic victory.

Speaking Engagements

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The Roundup

Oil & Gas

Enerplus Resources (TSX: ERF.UN, NYSE: ERF) is selling its 15 percent stake in the Joslyn oil sands lease to Occidental Petroleum (NYSE: OXY) for CAD500 million. Enerplus, which had invested CAD115 million in Josyln, will use the proceeds from the sale to pay down bank debt and fund acquisitions and expansions.

The sale will allow Enerplus to focus on its Kirby project, which is expected to produce about 10,000 barrels a day initially and up to 40,000 per day through future expansions. Enerplus Resources is a buy up to USD50.

Provident Energy Trust (NYSE: PVX, TSX: PVE.UN) sold a portion of its US oil and gas business, a 22 percent interest in BreitBurn Energy Partners LP (NYSE: BBEP) and a 96 percent interest in BreitBurn GP to BreitBurn Energy Partners for USD345 million. Proceeds from the sale will be initially applied to Provident’s Canadian senior credit facility.

Provident will continue to divest US assets in accordance with a strategic review announced Feb. 5, 2008. Its remaining US asset is a 96 percent interest in privately held BreitBurn Energy Co LP. The trust is looking to focus its efforts in Canada and on its midstream business. Buy Provident Energy Trust up to USD14.

Business Trusts

Aeroplan Income Fund (TSX: AER.UN, OTC: AOPIF) unitholders have approved the trust’s plan to reorganize into a corporation. The new company will be called Groupe Aeroplan.

The conversion plan is designed to allow Aeroplan to pursue acquisitions and invest in frequent-flyer programs. The change in structure was announced last month, spurred by concerns that Aeroplan may lose its tax-free status by exceeding foreign ownership limits. Sell Aeroplan Income Fund.

Extendicare REIT (TSX: EXE.UN, OTC: EXMUF) closed an offering of CAD92 million principal amount of 7.25 percent convertible unsecured subordinated debentures and 3.565 million trust units at CAD9.70 per unit for aggregate gross proceeds of CAD34.6 million. The REIT will use proceeds to fund internal growth projects under development and to repay debt. Hold Extendicare REIT.

Non-Trusts

Bank of Nova Scotia (NYSE: BNS, TSX: BNS) has agreed to buy a 47.5 percent stake in Peru-based pension fund manager AFP ProFuturo for CAD33 million. The deal allows Scotiabank to expand in one of Latin America’s fastest-growing economies via Peru’s fourth-largest pension fund.

Peru’s GDP is on pace to grow by 8 percent this year after expanding 9 percent in 2007. ProFuturo has 23 percent of the market for pension fund customers and 17 percent market share by industry revenue. Bank of Nova Scotia is a buy up to USD58.

Canadian Hydro Developers (TSX: KHD, OTC: CHDVF) has increased its existing agreement by CAD312.5 to give it a total of CAD611 million of facilities. Prior to the recent amendment, Canadian Hydro’s CAD370.8 million credit facility consisted of CAD233.5 million in the aggregate of construction credit facilities for the Melancthon II Wind Project and certain Blue River Hydroelectric projects, a CAD72.3 million acquisition facility for Le Nordais Wind Plant and a revolving operating facility of CAD65 million with an existing syndicate of four corporate lenders.

The new facility includes CAD233.5 million of construction facilities for Melancthon II and Blue River, a CAD292.5 million construction facility for the Wolfe Island Wind Project and a CAD85 million operating facility. Canadian Hydro Developers is a buy up to USD5.95.

Talisman Energy (TSX: TLM, NYSE: TLM) is spending USD315 million for stakes in two oil blocks in the Kurdistan region of Iraq. Talisman will hold a 40 percent stake in Block K44; Canada-based WesternZagros Resources will hold 40 percent, and the Kurdistan Regional Government (KRG) will retain the remainder. Talisman plans to spend USD80 million developing the asset.

Talisman also entered into a two-year seismic services agreement with the regional government on Block K39. Talisman has an option to take a 60 percent production stake for at least a year following completion of the seismic services contract. Initial work is expected to cost USD10 million to USD15 million. Talisman Energy is a buy up to USD26.