Profit from Canada's cheap telcos
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Associate Editor
David Stevenson Mar 12, 2010
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You can generally bank on politicians to cause confusion. The Canadian government is no exception. Its latest statements on telecom companies (telcos) have baffled the stockmarket. However, savvy investors who can see through the smoke will spot an opportunity to profit.
Until now, the telecoms sector in Canada has been almost a closed shop. The federal Telecommunications Act has stopped foreign ownership of the country's phone companies exceeding 20% of a firm's voting shares. So far so cosy for Canadian domestic telcos. But there's a big downside. Competition and investment have been stifled by the rules, "long criticised as overly restrictive and out-of-date", says Money.canoe.ca.
So a change was overdue and, indeed, expected last week from Canada's officialdom. In last Wednesday's annual key policy announcement – 'the throne speech' – the Conservative government strongly hinted that both the country's telecoms and satellite industries would be opened up to extra overseas money. This would "give Canadian firms access to the funds and expertise they need". However, the message was then watered down. Thursday's budget speech spotlighted only the satellite sector as an immediate target for liberalisation. The telecoms sector overall would see just "increased competition and investment".
The result? "Stunned silence and abject confusion," says Ian Marlow in the Globe and Mail. "Satellites are an obscure part of the broader telecom industry that haven't been the subject of foreign interest in years." A 'regulatory source' quoted by Marlow said the government has "over-promised and underdelivered". In short, it's all got a bit messy – for now. The government says it will clarify timing "in the coming weeks".
However, that aside, the longer-term picture looks clearer. "The good news is that two earlier government-sponsored reports have given a road map" for liberalisation, says Peter Rhamey at BMO Capital Markets. Indeed, "there's a general sense that it's only a matter of time before the rules are changed, at least in the cellular sector", says Telegeography's CommsUpdate.
The telecom industry also wants to see cash from outside the country boosting both wireless and landline services. Back in 2003, the then boss of Canadian telco BCE told a government Standing Committee that he "believed the complete removal of ownership restrictions is inevitable". That's because nearly everyone would benefit. More investment should bring in faster and cheaper broadband services.
In addition, if new Canadian government policy helps reduce borrowing costs – because carriers would be freed to shop around more widely for funds – firms' expenses and consumer prices could both drop, says telecom consultant Mark Goldberg. "If [the government] fully liberalises foreign ownership, it's likely to improve stock prices for everybody, because it removes restrictions on who can buy Canadian carriers."
And that's the win for investors. "Depending on what rules are relaxed, and when, it could mean widespread consolidation," says Marlow. "Mergers and acquisitions could ricochet through the telecom industry. Bell and Telus [one of BCE's major rivals] could merge. Cable companies could sell out to large American companies. Rogers might buy out Cogeco Cable Inc" – both are also Canadian telcos. "And huge international conglomerates might chose to invest in small Canadian start-ups." So, exploit current uncertainty to nab the sector's key players on the cheap. We look at one below.
The best bet in the sector
BCE (CN: BCE), formerly Bell Canada Enterprises, is Canada's largest telco, with 2009 revenues of C$17.7bn and a market cap of C$23bn. It provides landline services directly in the east (in Ontario and Quebec) and also via its 44%-owned affiliate Bell Aliant in the Atlantic provinces. At end-2009 it had 6.8 million wireless subscribers, up 5% year on year. It's Canada's largest provider of high-speed internet and video services, each with about two million customers.
BCE already "boasts healthy cash flow and strong brands", says Michael Santoli in Barron's. While the company isn't immune to price wars, there's plenty of room for overall industry growth, agrees Simon Flannery at Morgan Stanley. Only 67% of Canadians are wireless customers, as opposed to 92% in America.
An ongoing cost-cutting campaign is feeding through into analysts' forecasts of a 7% climb in net profits in 2010. That puts the stock on a forward p/e of just 11.4, with a forward yield of 5.7%. "The shares could easily trade 10% higher over the next year," says Santoli. Add in the dividend payout, and they offer a "high-teens percentage return". Any future foreign investment in the sector could put the icing on the cake.
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