MONTREAL The C$51.7 billion (US$49.3 billion) leveraged buyout of BCE Inc. was easy on debt by design, according to an executive with the Ontario Teachers Pension Plan, one of the three purchasers.
But the relatively light financing means the winning bidders for the company the C$100 billion Ontario Teachers plan, Toronto; Providence Equity Partners Inc., Providence, R.I.; and Madison Dearborn Partners, Chicago needed to invest more equity.
The Ontario fund is writing the biggest check; about $4 billion of the $8 billion equity in the deal is being contributed by the plan to acquire Montreal-based BCE, one of Canadas largest telecommunications providers.
Thats necessary because the debt markets that enabled megabuyout firms to gobble up huge corporations without putting much of their capital at risk have started to pull back. The easy debt days of just five months ago that facilitated the second largest buyout in history the $45 billion purchase of TXU Corp. by Kohlberg Kravis Roberts & Co. and TPG, formerly Texas Pacific Group are over. Its not likely that other firms will be able to swing $37 billion of debt for a $45 billion transaction, as was the case with TXU.
Debt markets began to pull back when troubles in the subprime mortgage markets led to hedge fund losses and fund closures. This, along with rising interest rates, is adversely affecting investor desire for the high-yield bonds that have been financing leveraged buyouts.
Opted for lower debt
Still, the winning bidders for BCE were not forced to accept a low amount of debt; they opted for it because of the realities of the telecommunications sector, said Jim Leech, senior vice president of Teachers Private Capital, the private investment arm of the Ontario Teachers fund. The telecommunications industry has high capital expenditures, Mr. Leech said. We dont want too much debt so we can invest in the plant.
One aspect of the deal that is raising eyebrows among other pension fund executives and alternative investment consultants is that plan executives are risking 4% of the plans total assets in a single deal, he said. When the BCE transaction closes, it will be one of the pension systems largest holdings, Mr. Leech said.
Buyout firms wouldnt risk 4% of a fund on a single deal, said one private equity adviser who declined to be identified. But Ontario Teachers officials believe that BCE is a good deal. We believe this is a good risk/reward balance, Mr. Leech said.
The BCE deal isnt the first time the Ontario Teachers plan invested a large chunk in a single company. In 1999, the plan wrote a $4.5 billion check to buy Cadillac Fairview Corp. Ltd., which became its real estate affiliate. At the time, the deal represented about 5% of total assets, he said.
That investment has worked out exceptionally well. We own it at 100%, Mr. Leech said.
Officials at the pension fund knew both companies well before they did the respective deals, and the pension fund owned shares in both companies before buying them.
Mr. Leech wouldnt say what return expectations fund officials have for BCE, but he commented; Over the last 17 years, (Teachers) Private Capital has returned more than 25% per annum, and we do not intend to dilute our record.
Certainly, there will be challenges.
On July 3, Fitch Ratings Ltd., New York, downgraded BCEs issuer default and senior unsecured debt ratings to BB-minus from BBB-plus and placed it on watch for a negative rating because the rating agency expects the buyers to increase debt to six times earnings before taxes, depreciation and amortization by the time the transaction closes in the first quarter of 2008.
Debt too high
While still low by overall buyout standards, the expected debt load is too high for a telecommunications business with cash flows that declined last year and had not shown much growth before that, said John C. Culver, senior director with Fitch in Chicago.
Theres certainly a concern with recent patterns of declining cash flow at a time when they are putting more debt on the company and theres pressure to invest in its wireless network, Mr. Culver said.
And there is a risk that conditions in the loan markets could change, which could increase the cost of the debt when the transaction closes, he said.
Not all institutions are comfortable accepting these risks to invest in directly in companies.
The C$143.5 billion Caisse de Depot et Placement du Quebec, Montreal, on June 26 dropped out of a consortium led by KKR and the C$116.6 billion Canada Pension Plan Investment Board, Toronto that was bidding against the Ontario Teachers plan for BCE. A Caisse spokeswoman said fund executives were barred by a confidentiality agreement from discussing reasons for their withdrawal.
Still, less leverage available to private equity firms might increase co-investment opportunities, which many of the largest institutional investors desire.
As the debt markets tighten up and less of the deals are financed by debt, there is more opportunity for co-investment to fill in the extra equity, said Monte Brem, founder of StepStone Group LLC, a La Jolla, Calif., private equity consulting firm.
Private equity investors have been concerned with the debt markets because its the first pullback in a while, said Mario Giannini, chief executive officer of private equity consultant and alternative investment manager Hamilton Lane, Bala Cynwyd, Pa.
The question is whether the debt pullback is permanent or is caused by a temporary imbalance between the amount of debt to be sold and available capital, Mr. Giannini said.
Private equity firms may have to downsize their takeover targets, he said.
The change in the debt markets has more of an impact on the price that can be paid for some deals and, particularly in public to private deals, the price may not be enough to get the deal done if debt terms and availability decrease, Mr. Giannini said.