PrefBlog

Each of the headlined issues has been redeemed as advertised: BAM.PR.T and CCS.PR.A were specifically noted on this blog, while CAC.PR.A was a scheduled maturity.

BAM.PR.T has been removed from the InterestBearing Index, while the other two were assigned to “Scraps” at the time of their redemption.

S&P has announced:

that the ratings, including the  ‘A-‘ long-term corporate credit rating, on Montreal, Que.-based telecommunications service provider BCE Inc. and its subsidiaries will remain on CreditWatch with negative implications, where they were placed April 17, 2007.
…
The transaction will require about C$38 billion in cash to buyout existing BCE common and preferred shareholders. Details of how the buyout will be financed are not currently available. However, if fully debt financed, the result would be adjusted debt leverage of more than 8.5x–and a rating within the ‘B’ category. Alternatively, if the sponsors’ equity contribution is sufficient to achieve an initial debt leverage of less than 7x, and there was the potential for further reductions in the medium term, the rating would likely remain at the mid-to-low end of the ‘BB’ category.

This opinion – regarding the difference between 8.5x and 7x leverage – is very interesting, as it allows a back-of-the-envelope calculation of the fair value of the preferreds. Please note that back-of-the-envelope is a very generous way of describing the following calculation – NOTHING IS KNOWN, or will be known, until full details are out … and we’re playing with mutually exclusive what-if scenarios anyway (which at least has the advantage of making it very difficult to prove me wrong. Ah, the joys of portfolio management!)

So, let’s look at the leverage ratios. S&P puts the total enterprise value at 51.7-billion. Therefore, to achieve 7x leverage, there will need to be about $6.5-billion equity, while the 8.5x leverage ratio requires only $5.4 billion. THEREFORE, the difference between a “B” and a “BB” rating will require about $1-billion in equity.

The new debt, that will be issued at whatever the new rating is, was estimated by DBRS yesterday to be in the $26-28-billion range. Let’s call it $27-billion for the sake of an argument. And we’ll also make the ballpark assumptions that while “BB” debt could be sold at a spread of 400bp to treasuries, “B” debt will cost them +440bp.

The 40bp difference, applied to debt of $27-billion, implies a difference in financing cost of $108-million per annum, which we will round to $100-million.

Now, here’s where things start to get interesting! It’s going to cost Teachers somewhere around $2.75-billion to buy the preferreds, so let’s look at two scenarios:

i) Preferreds are purchased by Teachers and refinanced with junk at +440, swapped into CAD for an effective refinancing charge of call-it-maybe 9%.

ii) Preferreds are left alone and are presumed to pay 6% (Canada Prime) as dividends, which is grossed up to cost the company a yield-equivalent of 8.4%; payable on $2.75-billion is $231-million, BUT the subordinated nature of the preferreds is enough to convince S&P (and the portfolio managers who actually buy the paper) that the new debt is “BB”, thus saving $100-million in financing charges (and ignore currency conversion, so we can keep the numbers straight). Therefore, the net cost of keeping the preferreds is about $130-million on debt of $2.75-billion, which is a rate of 4.7% which isn’t too much above Canadas!

So … the more I look at it, the less sense it makes to me that the preferreds are being purchased. Note, however, that assiduous reader Drew took the view that the quicker & cleaner plan of arrangement was greatly preferrable to a chancy auction (in the comments to yesterday’s post).

Let’s look at it another way. Teachers has indicated that they are choosing option (i). What happens if another bidder says “Oh, no, we’re gonna go for option (ii)”. How much money is that worth?

The difference on the two financing charges is 430bp, on $2.75-billion, which comes to $118-million p.a. For that $118-million, they could borrow another $1.25-billion at a rate of 9.4% and give all this money to common shareholders, which comes to about $1.50 per share. Note that the phrase “all this money” is a little suspect, as there are knock-on effects, but this exercise has led to a rather interesting answer, hasn’t it?

All readers should be warned that in performing these calculations I am operating way outside my field of expertise. Don’t take any investment action based on any of this! I welcome all comments and critiques of my math – there may be something very obvious that I’ve missed.

BCE has the following preferred shares outstanding: BCE.PR.A, BCE.PR.C, BCE.PR.E, BCE.PR.F, BCE.PR.G, BCE.PR.H, BCE.PR.I, BCE.PR.R, BCE.PR.S, BCE.PR.T, BCE.PR.Y & BCE.PR.Z

Update: With all these numbers flying around, let’s think about the market value of the prefs in the absence of an offer. If new debt is going for +400 to +440, it would seem reasonable that a preferred shareholder would demand at least +500 interest equivalent to hold the paper. That would be call-it-maybe 9.5% swapped to CAD. If we assume that the archetypal BCE prefs pays 6% on $25.00 p.v., and the archetypal investor has an interest-equivalency factor of 1.4, that implies a requirement for 6.8% dividend yield, which implies a price of $22 on the preferred.

Note, however that top-rated perpetual credits are yielding 5% dividend, which is 7% interest equivalent, which is Canadas +250bp, which compares to long bonds at around +100, which implies a spread of +150bp (pref/bond) as opposed to the +60bp (junk pref/junk bond) posited above. If Mr. Archetypal Investor wants 10.5% interest-equivalent for holding a pref, that’s 7.5% dividends, which implies a price of $20.00

DBRS hosted a conference call today shortly after releasing their updated assessment of the credit. The gist of the call was: ‘We don’t know anything much and won’t know anything much until the proxy material arrives in 60-odd days, but we’re being paid to talk about it anyway, so here goes!’.

I find this transaction fascinating, and not just because the plan to acquire the prefs will almost certainly cause MAPF to underperform in July. Why is it being done as a plan of arrangement, which gives the preferred shareholders a right to vote, which I presume is the trigger for the offer?

I have to be careful here, since I am not a securities lawyer – and don’t want to be a securities lawyer – but according to Blakes:

Arrangements are often the preferred acquisition structure in any friendly merger, as the structure allows the acquirer to complete the transaction in one step, unlike a take-over bid which will always require a second step to acquire 100% of the outstanding shares, either through a compulsory squeeze-out of the untendered shares under the applicable corporate statute or by way of a second stage amalgamation transaction. A court-approved plan of arrangement can be completed in a similar time frame as that of a take-over bid and allows companies to merge or combine in a single step, subject to obtaining approval from the target company’s shareholders and meeting any other conditions imposed by the Court.

A very quick reading of the government’s current policy regarding plans of arrangement didn’t ring any bells for me either.

So why isn’t it being done, for instance, the way Xstrata acquired Falconbridge (with the follow-up compulsory acquisition, with a guarantee of the extant prefs? Given that DBRS expects BCE to be a junk credit after the plan of arrangement:

However, DBRS believes BCE’s financial risk profile will be negatively impacted should this transaction close under the terms being recommended by BCE’s board. Teachers’ has indicated that approximately $8 billion of equity will be used to effect this transaction. Therefore, DBRS believes that additional leverage used to accomplish this transaction could add as much as $26 billion of debt to the BCE capital structure assuming a highly leveraged financing of 20% equity contribution is used. Additional debt of this magnitude results in credit metrics deteriorating significantly. For example, the resulting debt-to-EBITDA metric could surpass 6 times. This higher financial risk profile is indicative of bonds rated in the speculative grade range

(“speculative” is the nice way of saying “junk”) it seems rather odd to me that Teachers will voluntarily aquire the prefs. One thing that may make sense is that it simply gives them a lot more flexibility in the future – the company can be chopped up or taken public again without the complicating factor of the preferreds. Seems like a high price to pay, though.

One thing that did come out in the DBRS conference call (which, according to DBRS:

will be available until close of business day Tuesday, July 10, 2007, and can be accessed in North America by dialing 1 800 408 3053, quoting confirmation code 3227900#.

so get your call in now!) is that private equity does not like to have debt come due during the anticipated holding period, which goes a long way towards explaining why a lot of near-term debt is going to be called. Presumably, this relieves the private corporation from the necessity of going cap-in-hand to the market and lifting their skirts for inspection at a possibly inopportune time.

It is clear from all the standard language in the prospectuses for the BCE issues that preferred shareholders are not entitled to notice of shareholder meetings or to vote (the plan of arrangement, being a direct change to their rights, being an exception to this). However, it is not clear to me whether they are entitled to receive financial statements. Could this be the reason?

I’m just a poor dumb fixed-income analyst. This private equity stuff is way too sexy for me. I’m just gonna wait for the proxy materials to be released – should be just before Labour Day – and until then refrain from speculation on the possible twists and turns this story could go through over the next year.

It should be noted that the BCE prefs had a monster day on the TSX, as expected. There’s still lots offered, well below the indicated Teachers acquisition price! Anybody who wants to take a view that the Teachers deal will close as indicated can make oodles of boodle by buying up a lot of these things. Of course, if anything goes wrong with this particular deal – like, f’rinstance, somebody scoops up all the common in a hostile bid – such a buyer will lose his shirt, but some people like that sort of knife-edge existence. Too exciting for me though – it’s just a dice throw, not actual investing as I understand it.

In the mean-time, I’ve got to start reading up on this stuff. In this particular case, the preferred shareholders have better (better! …. better! … BETTER!) credit quality than the bond holders, because they have to be persuaded to approve the plan of arrangement with their vote, while the bondholders have to sit outside in the rain and watch their investment grade portfolios turn to junk. This is – ahem! – rather an interesting thought, particularly if banks are allowed to engage in friendly mergers while their prefs are priced well below par …

BCE has the following preferred shares outstanding: BCE.PR.A, BCE.PR.C, BCE.PR.E, BCE.PR.F, BCE.PR.G, BCE.PR.H, BCE.PR.I, BCE.PR.R, BCE.PR.S, BCE.PR.T, BCE.PR.Y & BCE.PR.Z

Update: It is interesting to consider the language in the prospectuses of the two recent YPG issues.

YPG.PR.A:

On and after March 31, 2012, YPG Holdings may, at its option, upon not less than 30 days and not more than 60 days prior written notice, redeem for cash the Series 1 Shares, in whole at any time or in part from time to time, upon payment of the Redemption Price specified below. In addition, the Series 1 Shares will be redeemable at the option of YPG Holdings on or after March 31, 2007 upon payment of the Redemption Price specified below, provided that any redemption prior to March 31, 2012 shall be done for all of the then outstanding Series 1 Shares and shall be limited to circumstances in which Series 1 Shares are entitled to vote separately as a class or series by law or court order.

and YPG.PR.B:

Subject to the provisions described under “— Restriction on Dividends and Retirement and Issue of Shares”, the Series 2 Shares will be redeemable at the option of YPG Holdings on or after June 30, 2012, at any time, or from time to time, upon not less than 30 days and not more than 60 days prior written notice at the Redemption Price specified below. In addition, the Series 2 Shares will be redeemable at the option of YPG Holdings on or after June 30, 2007 upon payment of the Redemption Price specified below, provided that any redemption prior to June 30, 2012 shall be done for all of the then outstanding Series 2 Shares and shall be limited to circumstances in which Series 2 Shares are entitled to vote separately as a class or series by law or court order.