Bell Alliant BA CN S
March 21, 2013 - 1:57pm EST by
PGTenny
2013 2014
Price: 26.50 EPS $1.60 $1.58
Shares Out. (in M): 230 P/E 16.5x 16.7x
Market Cap (in $M): 6,000 P/FCF 12.2x 18.1x
Net Debt (in $M): 3,400 EBIT 650 650
TEV ($): 9,400 TEV/EBIT 15.6x 15.6x
Borrow Cost: NA

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  • Telecommunications
  • Canada
  • Capital intensive
  • Secular decline
 

Description

Bell Alliant quick notes     Canadian $$26.50/share, 6B market cap, 9.4B EV, 10.2B EV incl. Pension

Canadian Wireline pureplay, focused on ruralAtlantic provinces–Nova Scotia,Newfoundland,PrinceEdwardsIsland, and rural areas ofOntarioandQuebecProvinces.  Largest city isHalifax, roughly the size ofAnchorageAlaska. Lowest GDP per cap inCanada. 

 

  • History – spun off by BCE as an income trust.  No investment, just run for cash.  Converted back to Corp a few years ago.  BCE still owns 44%
  • Propped up by 7% dividend yield, but very overvalued.  All retail investor base.  Aside from BCE, add up all instutional ownership, just 7%.  So sleepy base, doesn’t seem like they’re paying attention.
  • Like most old copper wireline, tremendous 50% EBITDA margins, but in secular decline and very capital intensive

 

Secular Decline

  • Experiencing the same secular wireline issues as US & rest of world, but on a lag toUS–rural areas had much slower cable penetration, older/rural population slower to adopt wireless and much slower to cut the cord
    • 60% of revenue is local and long distance voice, rate of decline has been 5% this year (accelerated from 4% last year), rate of decline has accelerated every year for 6 years
    • Still a long ways to fall.      
      • UStelco wireline fell from ~95% share of households to ~40% today
      • BA has fallen from ~95% to ~75% today.
        • Cord cutting: 32% have cut the cord in US, (increases 4-5 points/year).  
          • ~10% have cut the cord in BA’s territories (~20% in overallCanada). Canadahas 4 new wireless entrants so prices are falling, all you can eat voice is emerging, cord cutting should accelerate.  New wireless competitor Eastlink cable just launched LTE service in BA’s footprint last month, which should help push people off wires. 
        • Cable substitution - 35% of remainingUSwireline market now gets voice from cable instead of telco (increasing 3-4 points/year)
          • ~20% of BA’s footprint has gone cable.  Cable came late to BA’s footprint, in ’05 BA’s footprint only 15% covered by cable, now ~72% covered (UScable coverage was ~70% back in 2006).
    • Margins -- Revenues falling off are extremely high margin revenues with little associated cost, as you lose the revenue, fixed cost base is stranded, magnifying margin impact.  (BA has some of highest margins anywhere in telco, for now).  BA has done a great job cost cutting, CEO Karen Sheriff is reportedly very no-nonsense, cut out fat aggressively since taking over.  But you can only cancel your corporate country club memberships once, so cost saves will increasingly become more difficult.   
    • BA trying to fill revenue hole by rolling out Fiber.  It’s a good commercial product that can compete head to head with cable, but has terrible economics.
      • Cannibalizes BA’s existing copper voice and data – lose those high margin revenues, strand copper costs, and adds the new cost structure of a second fiber network in order to serve these same customers
      • Real incremental revenue is the TV opportunity – but TV revenue comes at very low margins, content costs and new network costs attached.
    • Overall?  It would be heroic (but possible) for BA to keep revenues flat.  But hard to see how EBITDA declines don’t continue, and very possible they start to accelerate. 
    • So it’s a tough fundamental business.
    • And highly levered -- $3.4B of net debt and preferred is 2.5x EBITDA, 3x including pension, at leverage limits – BTW that’s 5.5x EBITDA – Capex on this capital intensive biz. 

Valuation?

  • Valuation is pretty unbelievable.  17x earnings.  15x EBIT.  13.5x EBITDA – Capex.  More expensive than any other Canadian wireless or cable business (which are not in secular decline).
  • Why? Retail investor base, high dividend, and lack of scrutiny

What makes people wake up?

  • Think there is a high likelihood the dividend gets cut. 
    • Mgmt has made hard dividend commitments to the investor base and judging by the valuation investors clearly believe the dividend is safe. 
    • 7% dividend requires $435m cash a year.
      • In 2012 they generated ~$525m cash flow, leaving about $90m of room (BA reports it as $545m, leaving out $20m of preferred dividends which have to be paid before the common gets any.
      • But in 2013 they start paying taxes (old Canadian Income Trust) -- $125m
      • In 2015, have to start funding their pension again, $140m/yr (they are actually paying the pension as they go, paid $100m in FY12, so this is probably ongoing cash leakage before we actually hit 2015). 
        • No room to debt fund the dividend, they were recently downgraded to BBB and have committed to staying “investment grade”.  Can keep issuing preferred, which they’ve been doing a lot of lately (rating agencies count preferred only 50% towards the rating), though that of course requires a higher coupon that’s not tax deductible, so bad for the business long term and can’t buy them much time.
      • Don’t think the core business is going to improve, maybe $50m of room for reduced capex but beyond that it gets tight.  They’ve done a great job cost cutting, but it’s a losing battle, they are churning ~70% margin legacy voice revenues and trying to keep revenue flat with ~20% margin fiber revs that have huge capex, not much of a path to success in that scenario.
  • 14.5x EBITDA – Capex.  If it should be 10x (I’d argue that’s still rich but at least more reasonable), 55% downside
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Dividend cut in '14.  Debt buildup at precarious ratings until dividend cut. 
    sort by    

    Description

    Bell Alliant quick notes     Canadian $$26.50/share, 6B market cap, 9.4B EV, 10.2B EV incl. Pension

    Canadian Wireline pureplay, focused on ruralAtlantic provinces–Nova Scotia,Newfoundland,PrinceEdwardsIsland, and rural areas ofOntarioandQuebecProvinces.  Largest city isHalifax, roughly the size ofAnchorageAlaska. Lowest GDP per cap inCanada. 

     

    • History – spun off by BCE as an income trust.  No investment, just run for cash.  Converted back to Corp a few years ago.  BCE still owns 44%
    • Propped up by 7% dividend yield, but very overvalued.  All retail investor base.  Aside from BCE, add up all instutional ownership, just 7%.  So sleepy base, doesn’t seem like they’re paying attention.
    • Like most old copper wireline, tremendous 50% EBITDA margins, but in secular decline and very capital intensive

     

    Secular Decline

    • Experiencing the same secular wireline issues as US & rest of world, but on a lag toUS–rural areas had much slower cable penetration, older/rural population slower to adopt wireless and much slower to cut the cord
      • 60% of revenue is local and long distance voice, rate of decline has been 5% this year (accelerated from 4% last year), rate of decline has accelerated every year for 6 years
      • Still a long ways to fall.      
        • UStelco wireline fell from ~95% share of households to ~40% today
        • BA has fallen from ~95% to ~75% today.
          • Cord cutting: 32% have cut the cord in US, (increases 4-5 points/year).  
            • ~10% have cut the cord in BA’s territories (~20% in overallCanada). Canadahas 4 new wireless entrants so prices are falling, all you can eat voice is emerging, cord cutting should accelerate.  New wireless competitor Eastlink cable just launched LTE service in BA’s footprint last month, which should help push people off wires. 
          • Cable substitution - 35% of remainingUSwireline market now gets voice from cable instead of telco (increasing 3-4 points/year)
            • ~20% of BA’s footprint has gone cable.  Cable came late to BA’s footprint, in ’05 BA’s footprint only 15% covered by cable, now ~72% covered (UScable coverage was ~70% back in 2006).
      • Margins -- Revenues falling off are extremely high margin revenues with little associated cost, as you lose the revenue, fixed cost base is stranded, magnifying margin impact.  (BA has some of highest margins anywhere in telco, for now).  BA has done a great job cost cutting, CEO Karen Sheriff is reportedly very no-nonsense, cut out fat aggressively since taking over.  But you can only cancel your corporate country club memberships once, so cost saves will increasingly become more difficult.   
      • BA trying to fill revenue hole by rolling out Fiber.  It’s a good commercial product that can compete head to head with cable, but has terrible economics.
        • Cannibalizes BA’s existing copper voice and data – lose those high margin revenues, strand copper costs, and adds the new cost structure of a second fiber network in order to serve these same customers
        • Real incremental revenue is the TV opportunity – but TV revenue comes at very low margins, content costs and new network costs attached.
      • Overall?  It would be heroic (but possible) for BA to keep revenues flat.  But hard to see how EBITDA declines don’t continue, and very possible they start to accelerate. 
      • So it’s a tough fundamental business.
      • And highly levered -- $3.4B of net debt and preferred is 2.5x EBITDA, 3x including pension, at leverage limits – BTW that’s 5.5x EBITDA – Capex on this capital intensive biz. 

    Valuation?

    • Valuation is pretty unbelievable.  17x earnings.  15x EBIT.  13.5x EBITDA – Capex.  More expensive than any other Canadian wireless or cable business (which are not in secular decline).
    • Why? Retail investor base, high dividend, and lack of scrutiny

    What makes people wake up?

    • Think there is a high likelihood the dividend gets cut. 
      • Mgmt has made hard dividend commitments to the investor base and judging by the valuation investors clearly believe the dividend is safe. 
      • 7% dividend requires $435m cash a year.
        • In 2012 they generated ~$525m cash flow, leaving about $90m of room (BA reports it as $545m, leaving out $20m of preferred dividends which have to be paid before the common gets any.
        • But in 2013 they start paying taxes (old Canadian Income Trust) -- $125m
        • In 2015, have to start funding their pension again, $140m/yr (they are actually paying the pension as they go, paid $100m in FY12, so this is probably ongoing cash leakage before we actually hit 2015). 
          • No room to debt fund the dividend, they were recently downgraded to BBB and have committed to staying “investment grade”.  Can keep issuing preferred, which they’ve been doing a lot of lately (rating agencies count preferred only 50% towards the rating), though that of course requires a higher coupon that’s not tax deductible, so bad for the business long term and can’t buy them much time.
        • Don’t think the core business is going to improve, maybe $50m of room for reduced capex but beyond that it gets tight.  They’ve done a great job cost cutting, but it’s a losing battle, they are churning ~70% margin legacy voice revenues and trying to keep revenue flat with ~20% margin fiber revs that have huge capex, not much of a path to success in that scenario.
    • 14.5x EBITDA – Capex.  If it should be 10x (I’d argue that’s still rich but at least more reasonable), 55% downside
    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Dividend cut in '14.  Debt buildup at precarious ratings until dividend cut. 

    Messages


    SubjectRE: Capex
    Entry03/22/2013 09:41 AM
    Memberdichotomy
    I would agree with this. All the US telecoms that have gone through a similar buildout are guiding for their Capex to drop from ~20% of revenues to 10-15% of revenue. For BA that extra 5% is worth $136M based on the low end of 2013 revenue guidance. 
     
    If EBITDA comes in the bottom of their 2013 guidance, $1,275M, backing out estimated maintenance Capex of 15% ($2730M*15% = 409.5M) of revenues would give EBIT of $865.5M. Minus taxes of $125M, pension of $140M and interest of $158M(same as 2012) you get earnings of $442.5. This at least covers the dividend for the year.
     
    Do you have any evidence that suggests revenue will decline at much quicker rates?
     
     

    SubjectA few questions
    Entry04/04/2013 03:59 PM
    Membermiser861
    Hi PGTenny, thank you for the good writeup. A few quick questions:
     
    - Are you worried about BCE making a bid to take out the other shareholders? An article from the Globe&Mail last October raises that prospect: http://www.theglobeandmail.com/globe-investor/investment-ideas/bell-aliant-investors-being-paid-to-wait-for-bce-bid/article4599778/
     
    - Seems like most of the new wireless plan structures only give unlimited local calling, with unlimited nationwide being for the top tier. Will this give Canadians a reason to keep the landline? Or will they still cancel the landline since long-distance may be roughly the same cost on either platform? (I.e., does the landline still give some advantage?)
     
    - I know many places in the U.S. have buried phone lines. I am wondering if some of the BA footprint has buried lines and therefore will be prohibitively expensive to pass with FibreOP.
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