DBRS Maintains BCE Preferreds "Under Review – Negative"

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.

8 Responses to “DBRS Maintains BCE Preferreds "Under Review – Negative"”

  1. Drew says:

    Probably the reason they are proceeding as a plan of arrangement is that it takes only one step to squeeze out the minority – if approved by the relevant stakeholders and the court the minority is forced to go along – rather than a take-over bid which is involves two steps – first bid and get at least two thirds of the shareholders to tender and then do an amalgamation or arrangement squeeze on the strength of the shareholdings that the bidder has just acquired.

    Further, and probably more importantly, Teacher’s wants to avoid starting an auction process, which would occur if it made a bid: everyone would stand aside waiting for a better bid, moving the transaction out of Teacher’s control. Teacher’s basically took the premium that would have gone to the equity holders and gave it to the preferred shareholders in order to purchase their votes and secure (along with the break fee) the Teacher’s deal.

    The role of the court is to assess the fairness of the transaction, principally on account of those stakeholders who have not had an opportunity to vote: in this case the bond holders. This is where they may run into a snag, for the reasons you have enunciated. But they, no doubt, have anticipated this. My guess is that they believe that it will be easier and cheaper than engaging in a bidding war with Telus to offer up something to the bondholders to secure their acquiescence, but only when it become necessary to do so. Interestingly, going the arrangement route may result in the holders of debt and debt-like securities being treated more equitably in relation to the pure equity holders. What’s also interesting is that fact that the equity holders aren’t up in arms about the fact that the premium offered on the preferred shares is rightfully theirs. If they come to this view, and if the amount of money involved is significant, the whole process may backfire on Teacher’s.

  2. Drew says:

    I’m told the closing market price is below the bid price. Perhaps this is because the market has seen the snag in the structure.

  3. jiHymas says:

    Thanks for your insights, Drew!

    Teacher’s basically took the premium that would have gone to the equity holders and gave it to the preferred shareholders in order to purchase their votes and secure (along with the break fee) the Teacher’s deal.

    But a break fee could be negotiated even in the absence of a plan of arrangement, couldn’t it? Just a plain vanilla friendly bid.

    What’s also interesting is that fact that the equity holders aren’t up in arms about the fact that the premium offered on the preferred shares is rightfully theirs.

    It could well be that a hostile bidder will indeed offer the common shareholders the premium that is rightfully theirs … and if it’s done with a tax-free rollover into shares of the aquirer, who knows what might happen? Everybody’s talking about Telus … why haven’t I heard anything about Rogers or RIM?

    One can construct endless intricate Machievellian schemes … perhaps the whole point of going the plan of arrangement/money for preferreds route is explicitly to leave some money on the table for rearrangement by a hostile bidder! I’m sure Teachers won’t complain if they get to sell their current common holdings at a fat price AND pocket a break fee at the same time!

  4. Drew says:

    The premium I was referring to is the amount allocated to the preferred shares in excess of their trading value, an allocation that in theory should go to the equity holders under a takeover bid.

  5. jiHymas says:

    The premium I was referring to is the amount allocated to the preferred shares in excess of their trading value, an allocation that in theory should go to the equity holders under a takeover bid.

    Sure, that’s what I thought you meant … although I would prefer to state the neutral alternative as the cost of refinancing as junk, rather than market value.

    Tough to calculate what that figure might be! American junk is now trading at about 290 bp over treasuries, which could (presumably) be swapped into CAD debt yielding about maybe 7.5%. This would imply a cheaper financing than the prefs in and of themselves, as they will currently yield 6% floating rate after tax, or call it 9% pre-tax equivalent.

    Things get more complicated when the knock-on effects of the deep subordination of prefs and this effect on the financing cost of more senior debt is considered … and this is how investment bankers earn their daily bread … and I have no more wish to become an investment banker than I do to become a securities lawyer!

    Long BCE bonds are now quoted at 300-325 bp over Canadas, which makes the premium entirely dependent upon the knock-on effect on other debt. As previously noted, other issues with similar terms (BBD.PR.B/D, IQW.PR.D, NTL.PR.F/G) remain outstanding & trading well below par.

  6. Drew says:

    To approach it on the basis of the cost of refinancing as junk presupposes, does it not, that it is reasonably likely that they would have to engage in such a financing. Is that the case, or are most of the preferred shares perpetuals?

  7. Cold Canuck says:

    Another aspect to consider is that Teachers may own a “pile” of BCE preferreds, so in essence it is not costing them a lot to be “generous”, moving money from one pocket to another.

  8. jiHymas says:

    Drew – All of the preferreds are perpetuals. But what they are doing with the current plan is refinancing them with junk – the money has to come from somewhere!

    Cold Canuck – I consider it unlikely in the extreme that Teachers owns any preferreds at all. Preferred shares make very little sense for a non-taxable investor … without the Dividend Tax Credit, they are inferior to bonds in just about any way you can think of (which is why I consider the effect of the plan of arrangement in giving them effectively superior credit protection so interesting).

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