SOME BEHIND-THE-SCENES moves that look a lot like estate planning for Shaw Communications founder and controlling shareholder JR Shaw – along with the recent deal his company put together to sell the former Mountain Cable system and the rights to wireless spectrum out west to Rogers Communications – make it seem like the outright sale of Shaw is not to far over the horizon, says at least one Bay Street analyst.
"We believe the RCI-SJR (Rogers-Shaw) merger is inevitable but this is not likely to take place within the next 20 months and will likely take place in about two to three years," wrote Scotia Capital analyst Jeff Fan in a research note to investors. "However, we think the likelihood of RCI-SJR merger has increased as the Shaw family and SJR have made a number of moves that support a sale/merger down the road. We also believe that the recent transaction indicates that SJR and RCI repaired their relationship and can work together strategically."
Ted Rogers and JR Shaw were friends and often worked together as they built their cable empires. Over the years the companies shared best-practises and kept open lines of communication. They famously swapped east-for-west cable operations in 2000 when Rogers traded Vancouver for Shaw's southern Ontario systems. Since they were both cable operators, Rogers and Shaw had their own geographic regions and did not compete in the marketplace against each other. When Shaw got into satellite TV distribution and each company dove into specialty broadcasting, the dynamic between the two changed somewhat but when Shaw looked to get into wireless by purchasing spectrum in the 2008 AWS auction, then Ted Rogers died in December of that year, and after that Shaw moved on Hamilton's Mountain Cable (a company right in Rogers' Ontario kitchen), that led most to believe the formerly friendly relations between the two corporations had cooled considerably. And, for a while, they had.
The $700-million deal between the two companies announced January 14th where Rogers has purchased the Hamilton-based cable system is signalling to some, however, that all is now well between Rogers and Shaw and that the former will purchase the latter, but not until about two-to-three years from now. "If this was going to happen in the near term, we do not believe the two companies would have executed the cable sale and spectrum option transactions. Why negotiate on those smaller transactions separately if there is a bigger transaction to negotiate?" writes Fan. "Also, from RCI's perspective, if it wanted to buy SJR in the near term, why would it pay $50M for the option on the spectrum. RCI is not permitted to own the spectrum until September 2014, which is 20 months from now."
On the Shaw side, the company recently took steps to secure its pension plan for its retired and current senior executives ? and it appears that the 78-year-old founder is in the midst of estate planning, both of which could signal his readiness to sell his controlling interest in the company, writes Fan. "SJR funded approximately 75% of the pension plan in Q1/F13 for its active and retired senior executives, capped the number of members and fixed the salary assumption based on 2012 figures. If the underfunded status was still in place when the real (merger) talks begin, it could impact negotiations given the plan beneficiaries consist of mainly senior management negotiating the transaction. RCI (and its shareholders) may find it difficult to cover the liability at that time. Funding the plan avoids the risk of losing the benefits for its members," writes Fan.
Then, last month, he notes, "JR Shaw transferred shares from his holding company where he has an indirect interest to his children?s holding companies where JR Shaw does not have an indirect interest. There was only one exception in which JR Shaw retained indirect interest. Although these transfers have taken place in the past this was the first instance that we are aware of that he has transferred to companies that he has no indirect interest. To us this appears to reflect estate planning," writes Fan.
"Let's put this into context. The SJR/RCI transaction was the first major strategic transaction between the two companies in over 12 years when they swapped east/west cable properties and effectively agreed to not encroach onto each others' territories. That was a 'pact' between Ted Rogers and JR Shaw. Within just one year after Ted Rogers' passing in December 2008, the relationship started to get rocky as SJR took possession of wireless spectrum licenses with the hope of competing in wireless (against RCI which is the largest wireless carrier) and then went out of its way to acquire Mountain Cable, which is in RCI's 'backyard'," adds Fan. "The relationship appeared strained until this transaction, which transferred Mountain and spectrum licenses to RCI (that's right, they are the same two assets that SJR acquired one year after Ted Rogers' death). Perhaps we are now back to where we were before Ted Rogers?s passing, when there was a mutual understanding between the two companies/families."
Fan's research note says Shaw will spend about $450 million of the proceeds from the most recent transaction on its cable and Wi-Fi network upgrades (which the company said it plans at the time the deal was announced) including new data centres. But, if the company is thinking sale, long-term, why spend? Why not rein in capex to boost cash flow for the best possible return?
"Our theory is that while that may work in other transactions, RCI knows SJR too well to entertain a transaction like that. We do not think RCI will want to incur significant investments post the merger," writes Fan. "The sale of non-core assets to RCI helps SJR obtain the capital necessary to make the investments that will protect subscribers and pricing power over the long term. Furthermore, the additional capital provides it with flexibility to reduce debt and signal to Telus that it has strengthened its financial position to compete which likely keeps Telus rational. By making the investments SJR's objective is to improve its network and service and make the asset 'bullet-proof' over the long term which we believe should enhance SJR?s value. In two years, there will be real visibility for lower capex and higher FCF. For RCI, it is also a 'win' because it needs the spectrum in the west for 4G LTE to narrow the gap vs. BELUS' spectrum position. Mountain Cable also is a natural fit in southern Ontario for RCI."
– Greg O'Brien
