DBRS Places Bell Canada/BCE Inc. Under Review with Negative Implications

DBRS Limited (DBRS) has today placed all ratings of Bell Canada (the Company) and its parent company BCE Inc. (BCE) Under Review with Negative Implications, following the Company’s announcement that it has entered into a definitive arrangement agreement to acquire all of the issued and outstanding shares of Manitoba Telecom Services Inc. (MTS; rated BBB with a Stable trend by DBRS). The transaction is valued at approximately $3.9 billion, including $928 million of debt to be assumed (the Transaction). The Company expects to finance the remaining portion of the value through a combination of cash/debt (DBRS estimates approximately $1.4 billion) and equity (DBRS estimates approximately $1.6 billion). The transaction is expected to close in late 2016 or early 2017.

Bell Canada also announced that it will divest one-third of MTS’s postpaid wireless subscribers (approximately 140,000 subscribers) and roughly one-third of MTS’s dealer locations to TELUS Corporation (TELUS; rated BBB (high)), following the completion of the Transaction. Pro forma total Bell MTS subscribers after the TELUS transaction is expected to be 425,000. Proceeds from this transaction will be used to reduce the cash portion of the MTS acquisition financing.

DBRS forecasts that pro forma debt should peak at $22.3 billion upon closing of the Transaction, compared to $20.4 billion at the end of Q1 2016. As such, gross debt-to-EBITDA is expected to increase moderately to between 2.4x and 2.5x, from 2.36x in LTM Q1 2016. While this Transaction, in and of itself, is not viewed as materially negative to the Company’s financial risk profile, DBRS believes that the Company’s prolonged period of elevated financial leverage, coupled with continually mounting risks within the communications industry, has gradually eroded flexibility in the current rating levels. DBRS notes that the Company has completed several largely debt-financed acquisitions since in recent years, including: CTVglobemedia Inc. in 2011, Maple Leafs Sports and Entertainment Ltd. in 2012, Astral Media Inc. in 2013 and the minority interest in Bell Aliant in 2014, as well as over $1 billion in spectrum acquisitions in 2014 and 2015. This contributed to Bell Canada remaining above its internal financial leverage target (net debt-to-EBITDA of 1.75x to 2.25x) and a range suitable for the A (low) rating category.

DBRS had chosen to see through elevated leverage associated with previous acquisitions, based on the combination of benefits to the Company’s business profile and expectations of deleveraging to levels appropriate for an A (low) category within a reasonable time frame. In its most recent confirmation and following the Bell Aliant transaction, DBRS stated that it expected the Company to reduce gross debt-to-EBITDA toward 2.0x by mid-2017, and that failure to do so could result in a negative rating action. DBRS estimates that this previously understood schedule for deleveraging could be delayed by 12 to 18 months as a result of the MTS acquisition.

DBRS is reluctant to extend the deleveraging time frame once again due to the protracted period of elevated financial leverage, combined with intensifying competition in the wireless market, and increased risks in the media business, including structural (cord shaving/cord cutting and over-the-top video streaming) and regulatory changes (pick and pay) affecting television broadcasting, coupled with weakness in advertising. Furthermore, DBRS estimates that the Company’s pro forma free cash flow (after dividends) to total debt will remain below 5% over the near to medium term, which could limit management’s ability to deleverage by an adequate degree.

MTS is the incumbent telecom provider in Manitoba. MTS currently offers wireline voice services to roughly 439,000 residential and business NAS customers; wireless services to approximately 491,000 subscribers (roughly 50% share of the Manitoba market); high-speed internet to over 224,000 subscribers, and IPTV services to over 106,000 subscribers. DBRS believes that MTS benefits from a leading market position in Manitoba and relatively stable cash generation. In its February 22, 2016, press release, DBRS stated that the divestiture of Allstream in January 2016 was modestly positive for MTS’s overall credit risk profile, albeit from a low point within its existing BBB rating categories. In terms of size, MTS is relatively small, with $995 million of revenues and $459 million of EBITDA in 2015, which would account for roughly 5% of Bell Canada’s total revenue and EBITDA on a pro forma basis.

The Transaction is expected to be accretive to Bell Canada’s free cash flow immediately upon closing, due to the benefits of synergies and sizable tax-loss carry-forwards. The Company expects to generate roughly $50 million of pre-tax annual cost synergies, primarily from procurement improvements and operational efficiencies, as well as capex savings. Additionally, the Company will obtain substantial tax-loss carry-forwards totaling more than $300 million.

In its review, DBRS will primarily assess whether the Company possesses the ability and willingness to reduce financial leverage toward 2.0x by mid-2017. That review will encapsulate: (1) an update of its forecasts of the Company’s operating income in light of the Transaction; and an assessment of (2) Bell Canada’s free cash flow profile (after dividends) and financial management intentions of the combined entity.

DBRS aims to resolve the Under Review status once it gains clarity on the above-stated issues, which could be well before the close of the proposed transaction.

DBRS notes that the Transaction is subject to the approval of two-thirds of MTS shareholders. Additionally, the Transaction and the sale of MTS post-paid wireless subscribers to TELUS are both subject to customary regulatory and court approvals.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Companies in the Communications Industry, Rating Companies in the Television Broadcasting Industry, Rating Companies in the Radio Broadcasting Industry, DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers, DBRS Criteria: Preferred Share and Hybrid Criteria for Corporate Issuers and Rating Holding Companies and Their Subsidiaries, which can be found on our website under Methodologies.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.