BCE: Obit For A Mega-Deal

A deal once slated to make LBO history has collapsed.

The June 2007 all-cash agreement to acquire BCE Inc., Canada’s largest telecommunications company, was then valued at $48.5 billion, a figure that would have then qualified as the largest LBO ever. It was a valuation that wowed the buyout community, raising the bar on what the asset class was capable of in terms of deal size and borrowing capability.

But after a year-and-a-half spent overcoming regulatory and shareholder hurdles surrounding the privatization, the question of the company’s post-LBO solvency has killed the buyout. Accounting firm KPMG, hired by the deal’s LBO sponsors to evaluate the proposed capital structure of the post-acquisition company, was unable to deliver a positive solvency opinion for the deal by its scheduled closing date of Dec. 11.

Missing the scheduled closing date on the deal gets the acquisition group, led by Teachers’ Private Capital, the buyout arm of the Ontario Teachers’ Pension Plan, along with Providence Equity Partners, Madison Dearborn Partners and Merrill Lynch Global Private Equity, off the hook for the time being, but they could still face legal challenges.

On Dec. 8, just prior to the deal’s deadline, BCE announced its hiring of PricewaterhouseCoopers LLP to perform its own solvency opinion of a post-LBO BCE. The company also stated that it disagrees with KPMG’s assessment and that it believes PricewaterhouseCoopers’s work supports that position.

This move underscores BCE’s commitment to getting the deal done and, in the opinion of Canadian investment bank Canaccord Adams, raises the question of whether the buying group put forth its “best efforts” to close the deal.

“We believe the ball [is] now in Ontario Teachers’ court. Under its responsibility to make its best effort to close the deal, Teachers’ could at least enter into discussions with BCE to determine if the basis for the KPMG solvency opinion was correct,” the investment bank said in a research note.

In its statement acknowledging the termination of the deal by the purchasing group on Dec. 11, BCE said it would be “demanding” payment of a C$1.2 billion break-up fee related to the transaction. It also noted, rather ominously, that: “The Purchaser has taken the position that it is not obligated to pay the break-up fee,” signaling a conflict that could result in legal action.

At press time, the deal’s C$51.7 billion value had declined to $41.2 billion in U.S. dollars, meaning it was the largest LBO in the current pipeline by far, but it still would have been short of the title of largest buyout ever, which now remains the $45 billion take-private of TXU Corp. by Kohlberg Kravis Roberts & Co., TPG and GS Capital Partners in October 2007.

As originally conceived, the deal valued BCE shares at C$42.75 each, a 40 percent premium to their average trading price in the first quarter of 2007. At that time, the deal’s capital structure included more than $21 billion in term loans, a $2 billion revolving credit line, and a bond offering upwards of $11 billion, according to Reuters Loan Pricing Corp. The equity contribution would have accounted for less than 20 percent of the total price tag, a figure unheard of in the current credit environment where equity makes up more than 40 percent of the average capital structure.

In its negative assessment of BCE, KPMG called to the fore the teetering economic climate and the hefty amount of leverage BCE would be shackled with as reasons for the company’s probable insolvency.

Rumors earlier this month that the buyers may seek a minority interest in BCE as a backup to the original deal were quickly quashed by the company. “While it is BCE’s policy not to comment on rumors or speculation, in the interest of its shareholders, BCE is today confirming that no such offer has been made,” the company said in a statement on Dec. 5. Prior to the announcement, an anonymous source told Reuters that a deal for a C$8 billion to C$10 billion minority stake was in the works for the company, which would then remain publicly listed.

The deal also averted a potential crisis late last month regarding its debt package, when Citigroup Inc., the largest lender in the deal, received a bailout commitment from the U.S. government in exchange for a 7.8 percent stake in the bank. Relief from that dodged bullet was short-lived however, as BCE announced the likelihood of the negative KPMG opinion shortly thereafter.

Though it is the largest deal to fall victim to the credit crunch and the worsening economy, it is not the only one. The fate of the second largest deal in the current LBO pipeline—the $10.1 billion acquisition of Huntsman Corp. by Apollo Management’s Hexion Specialty Chemicals—is also in doubt. Credit Suisse and Deutsche Bank cancelled their financing packages for the deal on Nov. 1.

BCE generated C$4.46 billion in revenues in Q3 2008, a slight 0.4 percent drop from the C$4.48 billion it generated in Q3 2007. EBITDA, too, was down 1.4 percent to C$1.77 billion from $1.79 billion for the same three-month period the year before. The company, whose origins stretch back to the original Bell Canada incorporated in 1880, currently has $2.8 billion of cash on hand, and its current capital structure is considered solvent by KPMG.