TORONTO – With the privatization of Bell Canada looking like it’s dead, what with the release last week that KPMG can’t deliver a positive opinion on the solvency of the big telco post-deal, speculation has run rampant that Telus might still be interested in merging with Bell.
Scotia Capital analyst John Henderson issued an investor’s report saying that he believes there’s a 15% chance Of “Belus” happening. Telus did seriously want to kick Bell’s tires back in mid-2007 when the Ontario Teachers Pension Plan and its partners put together its deal to buy Bell, but the western telco never did make an offer.
“We believe BCE and Telus are strongly motivated to enter into merger discussions,” writes Henderson. “Merger synergies are significant… and should lead to material 32% value creation for both sides. Whereas some of these synergies will be achieved by the HSPA overlay deal… none of those savings has been reflected in either company’s share price in our view, due to near term EPS dilution caused.”
However, the Competition Bureau and CRTC might have an awful lot to say on the matter, should it ever proceed, especially when it comes to the wireless sector.
Nevertheless, here’s Henderson’s top ten list of reasons regulators might support a Belus proposal”
1. $10 billion of merger synergies improves competitiveness. We estimate merger synergies at 4% of combined operating expenditures and 5% of capex. The net present value of these synergies less integration costs amounts to $10 billion. A lower cost structure better enables Belus to compete in an increasingly competitive market.
2. Competition is fierce and getting worse. BCE and Telus face significant new competition from well-capitalized cable TV operators, upstart VoIP entrants, and existing and new wireless entrants (including Globalive, DAVE, BMV Holdings, Videotron, Shaw, EastLink, and a number of resellers including Virgin, President’s Choice, Sears, etc.). Bell and Telus are losing residential access lines at 8%-9% (per year) on average and we see no signs of moderation in future periods, as wireless increasingly competes with wireline. U.S. access line erosion continues to accelerate (down 11%-12% YOY), due in large part to increased wireless substitution.
3. Forbearance Directive says wireless, wireline, and cable compete for same customers. Industry Canada’s 2007 forbearance order instructed the CRTC to deregulate wireline markets regardless of incumbent market share, as long as there is the presence of three competing telecom networks – cable, wireline, and wireless – and the adherence to nine QOS tests by the ILEC. Clearly, this suggests Industry Canada considers wireless a viable contender for wireline market share and vice versa.
4. Wireless merger doesn’t increase pricing power. Putting Bell and Telus Mobility units together is unlikely to change the competitiveness in the market. Rogers is not going to shrivel up as a result, nor will the myriad of new competitive alternatives noted above (although some may fail for other reasons). Rogers’ competitive advantages improve with the launch of new HSPA devices such as the iPhone, to which Bell and Telus have responded through lower pricing. We believe the full impacts of Bell and Telus’ HSPA overlay will take five years to unfold. In the interim, merger synergies would give Bell and Telus the flexibility to compete on price and maintain their market share positions.
5. Rural markets demonstrate lack of pricing power in wireless. From 1986/87 to 2001 most of Canada’s rural markets faced a weak duopoly in wireless with ILECs holding 80% share or more and Rogers holding the balance. Rogers’ network coverage is typically weaker in those smaller markets, which explains the market share differential. In 2001, BCE and Telus signed a network sharing agreement, which gave them competitive access in each other’s rural markets with equivalent network coverage. Despite the near monopoly reality in rural markets for 15 years, pricing appeared to be no less competitive in those markets than elsewhere; ARPM fell continuously. Furthermore, the pace of decline showed no signs of accelerating, after the network sharing agreement was signed, bringing in more competition. This analysis suggests a significant lack of pricing power in wireless markets.
6. Efficiencies Defence is powerful in this case with $10 billion synergies. If the Competition Bureau comes to the unlikely conclusion Belus would have significant market power (defined as prices rising by 5% or more as a result of the merger), then Belus could use the efficiencies defence to argue its case. Guidelines established in 2006 suggest anti-competitive merger proposals may be approved if those proposals can demonstrate synergies in excess of the expected cost to consumers. We believe the merger synergies ($10B) would easily outweigh the potential cost to consumers resulting from reduced competition. In fact, based on the above analysis, we believe ARPM would continue to decline in this scenario.
7. Sask. Wheat Pool-Agricore United (Viterra) precedent for approval. The Competition Bureau’s March 2007 approval of this high-market share merger shows the Bureau’s new openness to considering mergers on the basis of the efficiencies defence. At the time the Bureau granted approval, Viterra expected to have a combined market share of 60% or more in ports and 42% in elevators after some small divestitures.
8. Merger synergies can help fund growing pension obligations. BCE had $15 billion in pension plan assets at year end 2007 and $17.5 billion of benefit funding obligations. Telus’ $7B plan is in better shape, but it clearly would be in a deficit position if measured today. We estimate the combined cash funding obligations will exceed $750 million in 2009 ($150M at Telus). Clearly, merger synergies can help to alleviate this burden.
9. Creation of a ‘Canadian champion’. Industry Canada has been supportive of nurturing the development of Canadian champions with strong re-investment potential. This deal is clearly supportive of that objective.
10. Independent poll shows high customer satisfaction in wireless. A poll of Canadian wireless users conducted by TNS Canadian Facts shortly after the arrival of number portability showed high levels of satisfaction with current cell phone providers in Canada (43% were very satisfied and 44% fairly satisfied).
