Bell Canada Just Made Preferred Shares A Little Safer

| About: BCE Inc. (BCE)

Preferred shares are often denigrated as dull investments. Now, with the deal to sell Bell Canada Inc. (NYSE:BCE) to Ontario Teachers' Pension Plan and two private-equity firms, they are even duller -- but that is not a bad thing.

Preferred shares are equities that resemble bonds. They are issued and redeemed at a set price, usually C$25. Most pay a dividend that is set for the lifespan of the shares, which means the share price tends to fluctuate with interest rates and the company's credit rating.

Recently, preferred shares in Canada and the United States have been hit by the prospect of higher interest rates. Bell Canada preferred shares, worth a collective C$2.7-billion, have suffered a double whammy because Bell has been a takeover target of private-equity firms. These buyout firms have a habit of scooping up all the common shares of their targets and adding loads of new debt to the balance sheets -- an estimated C$26-billion worth of debt in Bell's case, according to DBRS.

Credit rating agencies, which do not like bloated balance sheets, slash their ratings, and the price of bonds and preferred shares drops. Bell Canada preferred shares, that were trading at more than C$25 each a few months ago, fell to about $22 even as the common shares soared. That represents a 12% retreat that horrified investors who had counted on the preferred shares for their relative stability. Bond prices also suffered.

In the deal struck with private-equity groups last weekend, though, Bell Canada (formerly called BCE Inc.) will redeem its various preferred shares at a slight premium to par, or C$25. Tuesday, Bell's preferred shares rebounded by about 10% on the good news. Meanwhile, most bonds were left relatively unchanged.

"If any other consortium is going to do a privatization, I think a precedent has been set by Teachers and the board of BCE," said John Nagel, an analyst at Desjardins Securities who specializes in preferred shares. "The common, preferred and minority interests will have to be looked after in any subsequent deal."

Even if Telus Corp. (NYSE:TU), a rival telecommunications company, makes a subsequent bid for Bell, it will also feel pressured to redeem the preferred shares rather than leave them trading below par.

If there is a lesson to be learned here, it is that preferred shares just got a little safer. When a company is the target of a leveraged buyout, preferred shareholders will not be left to languish. Rather than getting hurt in the crossfire of a private-equity takeover battle, they are more likely to be scooped off the battlefield and placed safely on the sidelines.

This is an important consideration given the vast number of private-equity deals in the works these days and the rising importance of preferred shares to investors who can no longer count on income trusts to satisfy their income needs.

Dull? You bet. But dull can be good.