Did Private Equity Overpay for BCE?

| About: BCE Inc. (BCE)

As we all know, Canada’s largest telecom - BCE Inc. (NYSE:BCE) - has been having an auction. And as of Saturday, it looks like the deal is done. The winning offer comes from the group headed by the Ontario Teachers Pension Plan which includes Providence Equity Partners and Madison Dearborn Partners LLC. The final price is set at $42.75 per share.

I thought it would be interesting to run the BCE Inc. numbers, and see if these private equity players over-payed for this company.

Company Profile

From BCE Inc. website:

BCE is Canada’s largest communications company, providing the most comprehensive, and innovative suite of communication services to residential, and business customers in Canada.

Under the Bell brand, the Company’s services include local, long distance and wireless phone services, high-speed and wireless Internet access, IP-broadband services, information and communications technology services (or value-added services) and direct-to-home satellite and VDSL television services. Other BCE holdings include Telesat Canada, a pioneer and world leader in satellite operations and systems management, and an interest in CTVglobemedia, Canada’s premier media company.

This is a large cap stock with a market capitalization of $32.27B.

Company Fundamentals

Before I get started looking at the fundamentals, I have to warn you that I am only using the last 5 years of data. Why you ask? Let me tell you my little story:

I was collecting all my important numbers from the BCE 2006 Annual Report. It had 5 years worth of data all in this one issue. Great. I now have all the numbers I want from 2002 to 2006. Then I went to the 2001 Annual Report to collect another 5 years of data and I noticed that the numbers seemed way off from where I left off in 2002.

For fun, I take a look at the 2004 Annual Report. And guess what? That annual report was reporting different numbers from 2002 to 2004 then the 2006 Annual Report was reporting for that same period! So obviously BCE Inc. has gone back in and restated numbers from the past. Anyways, the short of it is that I really only have confidence in the numbers that show up in the 2006 Annual Report, so I am just going to use those ones.

Let’s get started.

Starting with the return on invested capital, management has been running at a 5 year average of 7.50%. Fairly low return in my opinion. The return on equity is better with a 5 year average of 15.75%. This shows that BCE Inc. has been using debt effectively. And debt is 46.8% of its total capital.

Its equity growth rate has been anemic at best. Over the last 5 years, it is negative 2.38%. Over the last 4 years, it has been 4.57%. And last year’s growth rate was 2.91%.

Earnings per share growth rate is a bit skewed. It seems that the EPS grew from $0.46 in 2001 to $2.62 in 2002. That of course is a HUGE growth rate of over 450%. The next two years had double digit negative growth rates. That huge growth rate in 2002 throws the 5 year average off.

Sales growth rates have also been anemic. Over 5 years, the sales growth rate is a paltry 1.21%.

These fundamentals don’t look enticing at all.

Dividend Fundamentals

BCE Inc. currently has a dividend yield of 3.86%. That is much higher than the S&P TSX Composite Index’s dividend yield of 2.34%.

Dividend growth rate has been almost non existent. In the last 5 years, there was only 1 dividend increase back in 2005. Over 5 years, that translates into a dividend growth rate of 2.20%.

The dividend payout ratio has been fairly high. In 2004, the dividend payout ratio reached 72.73%. It currently sits at just under 60% at 58.67%.

And cash flow growth rate has been negative over the last 5 years. I wouldn’t want to raise my dividends either with this kind of cash flow growth rates.

All in all, not the kind of company you would want to add to a superior dividend yielding portfolio.

Valuations Models

From looking at the fundamentals and dividend history, I have to guess that private equity over-payed for this one. Let’s see what our 3 different models say.

From a dividend yield perspective, the average high dividend yield over the last 5 years has been 4.90%. Therefore, if I demand this yield from BCE Inc., then I should be willing to pay $31.80. At the current price of $40.34, that is a premium of almost 27%. And of course, we know that private equity has offered even more at $42.75.

From the Graham number, I determined the model price to be $26.52. That implies a premium of 52% over the current price. Once again, looking overvalued.

For my new discounted present value calculation, I need to estimate the future EPS growth rate, the future P/E, the expected dividend yield and the future dividend growth rate.

Over the last 5 years, the historical P/E is 14.30. The current P/E is 18.69. I’ll use the more conservative P/E of 14.30 as my initial future P/E.

Equity growth rate has been anemic over the last 5 years. In fact, the 5 year average is negative! Can’t really use that number as a future EPS growth rate. However, the 4 year average, the 3 year average and the 2 year average are all hovering right around 4.20%. So I am going to use 4.20% as my initial estimate for the future EPS growth rate.

The analysts have its future EPS growth rate at 6.50%. So let’s be charitable to private equity and assume that the analysts are right (normally, I always use the more conservative value).

At 6.50% EPS growth rate, then the highest P/E investors should be willing to pay for that is 2 times. So that gives me a default P/E of 13 which is lower than my initial estimate of 14.30. I will use the 13 as the future P/E.

With that information, I determined that the future stock price in 10 years will be $52.66. Now I need to discount that to today’s dollar. I normally use a discount rate of 15%. However, I am going to take the dividend yield and dividend growth into account.

The average high dividend yield is 4.90%. Since that is the yield that will trigger me to buy the stock, I will use that as a constant dividend yield in the future. As for the future dividend growth rate, BCE Inc. has only raised its dividends once from 2002 to 2006 which leads to a 5 year dividend growth rate of 2.20%. Sounds good to me.

So, taking all this information, I have come up with a model price of $21.09. Even lower than the Graham number and it represents a premium of $91.25% over the current price.

See my calculations here.


All in all, this stock looks like a dog. And all three valuation methods show that private equity has overpayed by a long shot.

Now, I am sure that the private equity members will go in there and make management changes, increase efficiencies, sell off assets that aren’t producing, and all that good stuff that will make BCE Inc. a better more profitable company.

What do you think? Did private equity overpay for BCE Inc?

Full Disclosure: I do own shares of BCE Inc. I originally had purchased it for the dividend yield a couple of years ago when the stock was stuck in the $25 range. And that is when I learned that buying a high yield with no dividend growth is not as enticing as it first appears. Needless to say, I am very happy that private equity is willing to give me $42.75 a share. I will definitely take that money and find myself a superior dividend yielding stock with a consistently high dividend growth rate!