THE BID FOR BELL CANADA

ENTERPRISES (BCE)
MERGERS AND ACQUISITIONS
ASSIGNMENT

Group No: 11
Jishnu Mitra B18026
Varun Jain B18057
Vasu Gupta B18058
Udita Kaushik B18117

08/08/2019
THE BID FOR BELL CANADA ENTERPRISES (BCE)

1) Introduction

Bell Canada Enterprises (BCE) was known as the biggest and largest telecommunication
company in the whole of Canada. By 2006, Bell Canada Enterprises had one remaining
asset which was Bell Canada, which ran a revenue of $17Million. Bell Canada was the
market leader when it came to the wireless and wireline communication services – data
services – internet services domain. With just 4 competitors, it had managed to control
over 90% of the local lines, Bell Canada one that competed with Rogers Communication
and Telus.
During the inception of Bell Canada, they had phone lines that were laid out all across
Canada, across Ontario, across Quebec and across Maritime that acted as the
beachheads. Between 1980 and 1997, the federal government deregulated the telecom
industries and this bought along a lot of change. These changes also led to an increase
in competition. In the late 1990s, BCE then adopted a strategy that would converge and
amalgamate the content creation and the distribution within BCE. The strategy was not
successful and the new CEO Michael Sabia took over the reigns to sell the non core and
weaker assets of Bell Canada Enterprises. Michael did this with the idea of bringing the
focus of BCE back to its core functions. BCE meanwhile held both its core and non core
strategies with equal opportunities running but failed to satisfy the shareholders they
had. Sabia late realized that lack of future strategic plans was taken up by a private
financial buyer/mergers of equals/Telus etc.

Private Equity
Providence was a firm that invested in media , entertainment, communication and
information services. Providence had considered BCE as a lucrative target as it had a firm
cash position and a stagnant performance. BCE was also in the ring of KKR and OTPP, , a
global alternative asset manager which was Canada’s third largest pension fund and
BCE’s single largest shareholder. BCE was a lucrative target for the PE firm Providence
that invested in media, entertainment, communications and information services. BCE
had a firm cash position and a stagnant performance. BCC was also in the radar of a
global alternative asset manager KKR and OTPP which was Canada’s third largest
pension fund and BCE’s single largest shareholder.

Merger of Equals
Telus had cordial relationships with BCE, was the largest Telecom company in Western
Canada/ Being interested in a merger of equals with BCE, Telus had proposed to capture
more than 50% of wireless subscribers.

1|P ag e
THE BID FOR BELL CANADA ENTERPRISES (BCE)

2) Financial Problems

2.1) Potential Anti-trust issues with strategic combination

If the two companies, namely Bell Canada and Telus, are combined; they would have a
control of over 60% of the wireless market which would invite heavy scrutiny from
Canada’s federal regulators including Canadian Radio-Television and
Telecommunications Commission (CRTC).
Although it can be seen that there was limited overlap in terms of their operating regions
for majority of their wireline services, they were direct competitors for wireless as well
as the business customers. Combining both of them could result in reduced competition
ultimately leading to an increase in prices especially for the wireless services. It was
already established that the prices of wireless communication were already high in
Canada as compared to the international counterparts and this strategic competition
would further increase prices, lower innovation and could potentially result in lower
rates of usage.

In any move towards higher Industry concentration, there should be a balance between
the gains in synergies and market power loss for competition. Therefore, the companies
will have to put forward a strong case in order to make the merger happen and make it
a “Made in Canada” solution.

2.2) Impact on Capital Investment & litigations by increased Leverage

The sheer size of the Leveraged Buyout Deal is one of the largest attempted buyouts
that required a massive amount of funding from varied sources. In addition to that, BCE’s
proposed large indebtedness can hurt badly as with such high debts, there is reduction
in financial flexibility of the company. Higher interest payments result in squeezing out
other productive spendings like capital investment etc.

2.3) Effects of Dynamic Credit Market Conditions

In April 2007, there were signs of understandable nervousness in Canada’s Credit

Market conditions that indicated things could turn out for the worse. A major
foreshadowed Risk was that market conditions could be unfavourable as so to leading
the deal not being financed at the costs that were assumed.

2|P ag e
THE BID FOR BELL CANADA ENTERPRISES (BCE)

Success in financing will boil to the market’s reaction for higher junk debt and
interest’s costs for BCE could shoot up provided banks are unable to sell their debt.

2.4) Conditions of the Federal law

According to Canadian Federal law, companies were not allowed to own more than
46.7% of telecom providers with 80% acquisition price to be debt and reminder to be
equity, of which 50% had to source from Canada.
Given that the EBIDTA multiple was prices at 7x, the amount would be $5billion CAD.
This was a big obstacle for this transaction to complete.

2.5) Effects of Bureaucratic Structure

The current structure of BCE was highly bureaucratic with a bloated management. There
were many management layers. Thus the span of control was low. Thus a leaner
management was needed as one PE firm had estimated that the headcount reduction
would result in an improvement to the SG&A to sales ratio by 3% within 2 years.

One needed to slash some 2500 management jobs which accounted to 6% workforce
equivalent to 15% management in order to control the operating costs. This would
reduce the number of business units managed at highest level from 7 to 3. Another issue
was rightsizing the span of control. These were some issues needed to be catered to in
order to achieve the optimal workforce.

3|P ag e
THE BID FOR BELL CANADA ENTERPRISES (BCE)

3) Analysis

The time was ripe for BCE to be acquired. This can be proven from the analysis below:

Current Performance: Abysmal

The current performance of BCE was lacklustre at best. It had recorded a growth rate of
just 1%, whereas the industry average was 5%. It was losing its core wired telephone
service customers at an alarming rate. It had lost 8% of its customers in just 1 year. The
gains in customers in wireless and internet service domains were not adequate to make
up for this loss. The company was also writing off non-core businesses and assets such
Telesat Holdings Inc. to cut down on its mom performing assets.
Company Management: Not Performing Well

The management team owned about 0.2% of the shares. They were under pressure from
the shareholders to provide immediate measures. Due to this, they were not focussing
on long term resurrection of the company. Additionally, the organization was bloated in
terms of the number of top management members in the firm. There was a scope to cut
down management jobs by 15% (2500 employees). Apart from the excess management
capacities, the strategies adopted by them had not been successful as well. After a spree
of acquisitions in their core as well as allied industries, the convergence strategy
certainly appeared to be failing. They had to write off huge amounts of non-performing
assets

Potential of the company: High if Optimally Restructured

Although the current performance of BCE was disappointing it had a lot of future
potential. The wireless industry was growing at a CAGR of 11.9%. Lots of profits could
be captured in this segment if properly approached. There was also scope for higher
margins through reduced costs and optimized processes which could be achieved
through structural changes.

Therefore, BCE should be acquired to ensure its prosperity in the future. The firm has 2
ways to get acquired as explained and analysed below:

3.1) Acquisition by PE Investor

3 competing consortiums of PE firms, namely, KKR & CPP, Providence & OTPP and
Cerebrus were interested in taking over BCE. The financing of the takeover would have

4|P ag e
THE BID FOR BELL CANADA ENTERPRISES (BCE)

been as follows. The PE firms were interested in a leveraged buyout, where in they
would secure majority of the debt from secure senior bank debts.

Item Value
Total Transaction Value (Bn Cad $) 47.63
Debt/Value 0.8
Debt Required (Bn Cad $) 38.11
Debt Finance Available Through Senior Bank Debt 26.67
(Bn Cad $)
Cost Of Senior Bank Debt 8%
Unsecured Debt (Bn Cad $) 7.62
Cost Of Unsecured Debt 11%
Subordinated Unsecured Debt (Bn Cad $) 3.81
Cost Of Subordinated Unsecured Debt 13.5%
Equity Required (Bn Cad $) 9.52
Canadian Sourced Equity Required 4.76
Interest Costs CAD 3.48 billion

A PE firm, Providence, had been earlier refused to be provided with debt by Citigroup
because of the magnitude of the debt required. Therefore, to get access to secured bank
debt, the PE firms would need to prove high future returns from the acquired firm (BCE)
so as to cover the cost of debt, and also get a high return on equity.

Potential Future Value from BCE, Post Restructuring:

BCE Beta 0.7

Risk Free Rate 4.10%
MRP 6.90%
WACC 8.93%
Terminal Growth 4%
Rate

1. Value from Management Restructuring:

The goal was to transform BCE from a Bureaucratic inefficient company with too many
red tapes to an agile and flexible company with increased focus on process and resource

5|P ag e
THE BID FOR BELL CANADA ENTERPRISES (BCE)

allocation optimization. The bloated number management personnel were a major

reason of high SGA costs as a percentage of sales. The PE firms wanted to reduce this
cost by 3% points in two years.

CAD in Millions
Terminal
Year 2006 Values
Revenue 17255 350000
SGA/Sales 59% 59%
SGA (as per current % of sales) 10227 206500
Revised SGA/Sales 56.00%
SGA (if reduced by 3% points) 196000
Savings (NPV) 10500

The cumulative savings would be CAD 10.5 billion. This could be achieved if the
management is made lean and new management personals are recruited who are adept
in reviving firm.

2. Optimizing Capital Intensity Ratio:

The capital intensity ratio was currently 17%. The PE players wanted to bring it down to
industry standards of 14-16%. The savings achieved by such a improvement would be
CAD 7 billion.

CAD in Millions
Terminal
Year 2006 Values
Revenue 17255 350000
CAPEX by current Capital Intensity
Ratio 3133 59500
Current CAPEX/Sales 18% 17%
Revised CAPEX/Sales 15%
Revised CAPEX 52500
Savings (NPV) 7000

This could be achieved by focussing on the emerging wireless segment and reducing
maintenance and new capital investment on the wired line segment, as that segment as
a whole is on a decline.

6|P ag e
THE BID FOR BELL CANADA ENTERPRISES (BCE)

3. Working Capital Management

The PE firms believe they could restore the working capital to -8% of revenues from -1%
of revenues. This would amount to savings of CAD 24.5 billion. This could be achieved
through improving relations with suppliers. This would be possible as the restructuring
would improve the cash flows of the company, hence improving its credibility and
ratings.
Cost of integration = 3% of Transaction Value (industry standard) = CAD 1.48 billion

Interest Costs = CAD 37.1 billion (as in first table)

Total Value of the 3 savings = 10.5 + 7 + 24.5 - 1.42 – 3.48= CAD 37.1 billion

Total Transaction Value:

According to the information given, the PE firms are willing to pay about 7 times BCE’s
EBIDTA as the price for the firm.

Total Transaction Value EBIDTA

(CAD Million) (CAD Million) TTV/EBIDTA
MGM 4800 370 13
Toys R Us 6600 507 13
The Hertz Cooperation 15000 - -
Georgia Pacific
Coorperation 21000 2800 8
Preescale Semiconductor 17600 - -
HCA 33000 4469 7
Harrah's 27390 2600 11
TXU 45000 5200 9
Average 10
BCE 49196 7028 7

This is less than the average ratio of Total Transaction Value to EBIDTA of PE acquisitions
in the recent past in Canada, which is 10.

Also the value of synergies is CAD 42 billion, which is 75% of the transaction value.
Therefore, BCE should demand for a higher price for the acquisition.

7|P ag e
THE BID FOR BELL CANADA ENTERPRISES (BCE)

3.2) Strategic Acquisition by Telus

BCE Asset Value 36057

Telus Asset Value 16508
BCE Beta 0.9
Telus Beta 1.25
Combined Beta 1.01
Risk Free Rate 4.10%
MRP 6.90%
WACC 10.31%
Terminal Growth Rate 4%

1. Annual Cost Savings by Merging Wireless Businesses

This would give rise to annual cost savings of $ 1 billion (CAD 1.1 billion) after 5 years.
The NPV of this savings would be CAD 10.67 billion. This would be achieved through
elimination of redundant services such as call centres.
2. Revenue Growth for BCE
The Average Revenue per Person would improve significantly for BCE due to capability
addition from the side of Telus.

CAD in Millions
Year 2006 2007 2008 2009 2010
Growth 4% 4.06% 4.12% 4.18%
Revenue 17255 17945.2 18673.78 19443.3 20256.56

3. Optimizing Capital Intensity Ratio

Capital Optimizing Ratio for BCE would drop to the level of Telus (14%). This would be
possible through elimination of overlapping planned investments in resources and
research & development. Savings of CAD 8.2 billion could be achieved through this
method.

CAD in Millions
Year 2006 Terminal Values
Revenue 17255 273455
CAPEX by current Capital Intensity
Ratio 3133 46487
Current CAPEX/Sales 18% 0

8|P ag e
THE BID FOR BELL CANADA ENTERPRISES (BCE)

Revised CAPEX/Sales 0
Revised CAPEX 38284
Savings 8204

The deal, if it goes through would partly be financed through cash and partly through
shares. The cost synergies seem to be about CAD 17.5 billion after subtracting
integration costs. The revenue synergies are also quite significant, as the growth rate
would rise significantly. Along with higher growth rates, the Average Revenue per
Person would also increase significantly.
Therefore, the deal should take place at a significant premium.

4) Recommendations

According to our analysis, we recommend that the firm BCE is ripe for acquisition, as the
management team is not performing well, the current scenario is not well for the
company, but its future outlook looks positive.

For the acquisition, PE firms should be the first choice acquirers. This is because of the
significantly high cost synergies that can be achieved through corporate restructuring of
the management and the company. The PE firm acquiring BCE can sell it to a strategic
investor after a few years when the company has been able to realize higher value. This
would help the PE firm sell BCE for a high ROE.
For the purpose of acquisition, 80% of the transaction value would be secured as debt.
To ensure a lower weighted average cost of debt, the debt should be secured from
multiple sources. This would also reduce the covenants associated with the debt.
Additionally, before proceeding with the debt, the PE firm should ensure that the
macroeconomic factors are stable, and would remain similar for a few years so that the
synergy values are realized.

9|P ag e