Hello, buyouts‾ Telecom companies, once regarded as ill-suited to leveraged buyouts, are beginning to attract more attention from private equity firms.
Buyouts of telecom companies have been rare. Carlyle Group bought Hawaiian Telecom for $1.65 billion in 2005, in a deal led by former Federal Communications Commission Chairman William Kennard. But the acquisition only underscored why telecom can be so treacherous. State regulators put debt limits on the deal, limiting the return for Carlyle (see BusinessWeek.com, 8/17/06, 'Trouble in Carlyle's Paradise'). The combination of tight government regulation and high capital costs have tended to scare off private equity buyers.
But now the situation is beginning to change. The regulatory climate isn't nearly as tough as it was a few years ago, although it's still an issue. Broadband and wireless opportunities provide promises of growth, offsetting the decline of the traditional telecom businesses. And the telecom meltdown of 2000 has faded into a distant memory. 'Cash-rich private equity firms must find a place to invest their money, so they are willing to accept more risk in markets such as telecom,' says Phillip Phan, professor of management at the Lally School of Management & Technology at Rennselaer Polytechnic Institute (see BusinessWeek.com, 3/28/07, 'Prospecting for Private Equity Targets').
Buyout pressures to the north
The result is that there could be a flurry of telecom buyouts over the next year. Potential targets include the troubled wireless company Sprint (S), the regional wireless operator Alltel (AT), and the undersized Qwest Communications (Q). There's even the possibility of an acquisition of BCE (BCE), the parent company of Bell Canada, in what could be the largest buyout ever, at $45 billion including debt.
'Globally, I think you will see more LBOs in telecom because of restructurings,' says Phan. 'In the U.S., you will see them because of opportunities for consolidation.' The latest evidence of that shifting view is that a Canadian pension fund may push for a buyout of BCE. The Ontario Teachers' Pension Plan has had preliminary talks about a $26 billion buyout of BCE, The New York Times reported on Apr. 9.
The $92.5 billion pension fund declined to comment on the report. But Deborah Allan, an Ontario Teachers spokeswoman, said the fund is exploring its options with respect to BCE. Ontario is BCE's largest shareholder, owning 5.3% of the company, worth $1.35 billion. The shares, about 1% of the Ontario fund's assets under management, closed on Apr. 12 at $30.73, up recently on the takeover speculation but down from more than $100 back in 2000. 'We're not happy with what the share price has done over the last few years,' says Allan. 'We have to keep our options open. I can't comment on what these options may be because I don't yet know what they are.'
A different kind of fund
The fund denied an earlier report that it was considering teaming up with the private equity firm Kohlberg Kravis Roberts in a potential bid.
Ontario Teachers is unusual among pension fund because it makes its own private equity investments. Most pension funds function as limited partners, taking minority stakes in deals led by specialized private equity buyout firms. Teachers Private Capital, which the pension plan established in 1990, is a private equity fund in its own right, though.
Some of the factors driving Ontario Teachers' interest in BCE are specific to the situation. BCE wanted to take advantage of a tax loophole popular with many Canadian companies for the last few years by converting itself into an income trust.
Income trusts own many smaller Canadian companies. That has allowed them to avoid paying corporate taxes on distributions to the trusts, as long as those distributions are within certain limits. The Canadian government, concerned that it is losing tax revenue, has put an end to the game. The prospect of larger companies such as BCE turning into trusts led to tax reform last fall. Ontario Teachers may be compelled to own BCE directly so it can control costs more closely in a tighter regulatory and tax environment.
Appealing growth prospects
Private equity's interest in telecom goes beyond the Canadian tax issue, of course. Alltel has hired investment bankers to explore strategic options for the $22 billion company (see BusinessWeek.com, 12/29/06, 'Private Equity Reportedly Circles Alltel'). Private equity firms are considering a buyout, investment bankers say, attracted by the company's growth and profitability. The main sticking point is price. With an M&A premium already figured into the price, buyers are concerned that they could overpay and undercut their returns. Verizon Communications (VZ), which uses the same wireless technology as Alltel, could also compete with private equity firms for the company.
Sprint Nextel is considered a potential takeout target, even though its market cap is a dizzying $57 billion. It has long been the subject of rumors of that Comcast (CMCSA) and other cable TV operators will acquire it. But a report in March by Goldman Sachs' (GS) Jason Armstrong and Scott Marchakitus said that Sprint Nextel could make an attractive LBO, especially if operating results were to improve 10% or so above forecast (see BusinessWeek.com, 3/23/07, 'Why $80 Billion for Sprint May Make Sense'). Including debt and a takeover premium, the total price of a buyout could be more than $80 billion. That would be nearly twice as large as the pending $45 billion record takeover of energy company TXU (TXU).
Qwest would be a more affordable purchase. The Denver phone company has a market cap of $17 billion, up in recent years as the company has fought back from scandal. It has little in the way of wireless operations and its region is less attractive than either of the coasts, but its cash flow is strong enough to attract private equity interest.
None of the acquisitions are certain, of course. But the idea of a multibillion-dollar telecom buyout has gone from unthinkable to likely. A few years ago, it was the telecom giants that were making the major purchases in the sector. Now the balance of power seems to be shifting to private equity.
Rosenbush is a senior writer for BusinessWeek.com in New York.
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