Choosing Between Telus And Bell Canada In Today's Market

Given a choice between investing in Telus Corp. (TU) or Bell Canada Inc. (BCE), which telecommunications company looks like the better bet? Both stocks have been beaten up with the rest of the market over the past couple of weeks. Shares in Bell (formerly called BCE Inc.) have dipped 6.4% from their highs. Telus shares have fared even worse, suffering a drop of 21%.

The curious part about the Bell downturn, though, is that the company has been caught up in the unsettled credit market, which has cast doubt on whether the C$52-billion takeover offer from a private-equity group led by the Ontario Teachers' Pension Plan will go through.

Volatility in global credit markets is threatening dozens of similar merger deals because of rising borrowing costs. As a result, many stocks are trading well below their takeover offers. According to Breakingviews, an online financial commentator, six stocks of 25 that are at the center of big takeover deals worldwide are now trading at discounts of 10% or more. In a normal market, the discount would be close to zero.

In Canada, Bell Canada shareholders have been offered C$42.75 a share. But the shares closed Monday at just C$39.07, representing a discount of C$3.68 a share, or 8.6% (during the market's low point last week, the discount was as large as 11%).

This might look like a mouth-watering arbitrage opportunity, and it is if the deal goes through as planned. But the risk that it falls apart -- or its price is reduced -- is beginning to make the potential gains look less tantalizing. The deal hinges on the company's ability to issue more than C$33-billion in new debt to finance the takeover, which is hardly a sure thing in today's volatile credit market. The main fear is that the banks issuing the debt will demand new terms, including beefed-up covenants and higher yields to offset rising risks.

These fears have some substance to them. Home Depot Inc. (HD) has delayed the sale of its HD Supply unit by a week and there is speculation that private-equity buyers may reduce their earlier US$10.3-billion offer. In a regulatory filing, the home-improvement retailer said that no assurance can be given that the transaction will even close. How this deal transpires will have a huge impact on Bell Canada shares.

The uncertainty surrounding Bell Canada is making Telus look like a better bet. By just about any metric, it outshines Bell. For example, its earnings and dividends are rising faster, and yet the shares trade at a lower price-to earnings ratio. Its price-to-earnings growth ratio, a measure of how much investors are paying for profit growth, is less than one, versus nearly five for Bell Canada.

Telus, as you may recall, made merger overtures toward Bell this year but withdrew its interest because it could not gain access to Bell's financial data. Too bad, because a Telus deal would have wrung greater efficiencies out of the combined companies. Even better, a Telus deal would have given Bell shares some support because of the lower amount of debt required to pull off a merger.

But the best part of a Telus investment is the lower risk involved. The shares, which are at a 52-week low, are likely close to a bottom, giving them more upside potential than downside risk. On the other hand, Bell Canada's shares have a mere 9% upside and will dive if there are further gyrations in the credit market.

TU vs. BCE 1-yr chart: