BCE: Long Equity and Long Credit Trade Could Minimize Downside Risk

With shares of BCE Inc. (BCE) trading at C$37.65 as of Wednesday’s close, the implied odds of its C$42.75 per share buyout going through are only 57%, according to RBC Capital Markets’ Jonathan Allen.

At the same time, Bell credit spreads are trading well into non-investment grade range and imply nearly a 100% chance of the deal going through, the analyst told clients. As a result, he recommends a long equity and long credit trade to minimize the downside risk of the BCE privatization deal.

The analyst cited approval from the CRTC, the bondholder lawsuit appeal hearing that begins on April 28, and financing risk that is a result of weak credit markets as factors that may impede the closing, which is expected in late June.

If the deal does fail, Mr. Allen thinks BCE shares could fall below C$30 and could initially trade as low as C$27, based on a NAV of C$33, which includes the $1-billion break fee. He also expects the C$3.3-billion in proceeds from the Telesat sale could be used to repurchase shares around C$28 each.

But by adopting this credit and equity strategy, investors will get 13.5% upside on their shares if the deal goes through, along with a limited loss, or none at all, on the bonds.

If the deal does collapse, the analyst suggested that the gains on the bonds could offset much of the equity loss.

But what is the right bond to best hedge BCE equity? While the company has several debt issues that will be part of its new capital structure, Mr. Allen, who recommends closing out the credit/equity trade before the deal closes, highlighted four bond issues with suitable liquidity.

The first, Bell 7.65% Dec. 2031, is a subordinated issue that is considered to provide the most volatility, which is “a good thing when hedging against a volatile equity in a downside scenario,” he said. Its bid price is C$73, with a bid yield of 10.85% and spread of 675 basis points.

The others are all senior secured:

Bell 5.0% 15FEB 2017, $78.50, 8.5%, 500 bps

Bell 6.1% 6MAR 2035, $72, 8.1%, 475 bps

Bell 7.3% 23FEB 2032, $80.50, 9.3%, 525 bps

Mr. Allen said:

Based on where Bell credit trades, we believe it is safe to conclude that the bonds have limited downside as we approach the transaction close.