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BCE building in Montreal
BCE building in Montreal

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Have BCE shares peaked? Add to ...

A small army of sell-side analysts follow BCE Inc. - and they're a pretty non-committal bunch.

Of the 19 covering BCE's shares, 15 have a "hold" rating and four have a "buy," according to StarMine Inc.

Cynics might attribute this neutrality to BCE's disinterest in the services of underwriters now that it is busy buying back its common shares. More likely, it is a belief that BCE has become fully valued following a prolonged run-up in share price since the end of 2008. Including dividends, the return to shareholders has been over 100 per cent.

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The analysts' average 12-month target price is slightly under $39, not far from the current market price. The low expectations leave a low hurdle to clear, especially if positive surprises emerge as BCE's turnaround maintains its momentum.

Let's drill down on what only the top analysts have to say. Included in this group, according to StarMine, are Jonathan Allen (RBC Dominion Securities), Dvai Ghose (Canaccord Genuity), and Vince Valentini (TD Newcrest).

Positives

BCE is a diversified telecommunications company with considerable financial strength - free cash flow was 11.6 per cent of sales in the fourth quarter. Its solid dividend yielding 5.5 per cent, and prospects for modest capital-gains, make it a candidate for the conservative and income sections of portfolios, say bulls such as Mr. Allen.

The company's enterprise value currently stands at 6.1 times estimated 2011 earnings before interest, taxes, depreciation and amortization, about the same for Telus Corp. and Rogers Communication Inc. According to StarMine, other valuation yardsticks show discounts to peers - notably, the ratios of price-to-estimated 2011 cash flow (-19 per cent) and price-to-estimated 2011 book value (-28 per cent).

During the failed leveraged buyout bid of a few years ago, the company came under the influence of private-equity investors. This substantially heightened the focus on operating efficiency, capital allocation and shareholder value - sparking a corporate turnaround under a rejuvenated management team led by chief executive George Cope.

BCE has raised its quarterly dividend six times (a cumulative 41 per cent) since the fourth quarter of 2008, while maintaining the dividend payout ratio within the company's policy range of 65 to 75 per cent of earnings. During this period, $1.5-billion was spent on buying back shares. Management is targeting annual dividend increases of 5 per cent.

BCE's landline telephone business is eroding but management has bolstered the bottom line through cost cuts, such as workforce reductions, outsourcing call centers and consolidating real estate.

The wireless-communication division is also rebounding strongly, posting 12.2-per-cent growth in EBITDA in the first quarter of 2011. This was thanks to a cost-sharing alliance with Telus and a catch-up in smart phone sales.

Cost savings can't brighten the bottom line forever. However, "BCE is now becoming more of a revenue story," believes Mr. Allen, who has a $40 price target and "outperform" rating. In addition to momentum in the fast-growing wireless market, the April acquisition of broadcaster CTV is projected to boost earnings as its advertising revenues climb along with the business cycle, restructuring progresses, and CTV content is used to differentiate BCE distribution platforms.

Moreover, BCE has commenced the roll-out of Internet Protocol television (IPTV). By the end of the year, two million homes in Montreal and Toronto are expected to have access to the service, followed by another five million as the roll-out advances to other cities by the end of 2015. Not only should IPTV be a new source of earnings, but it should also give BCE a more competitive service bundle and help stem loses in landline services.

From what Mr. Allen has seen, the telecoms now have the better television offering for the next few years. Also, the U.S. experience appears to be encouraging. Major U.S. telecoms launched IPTV about five years ago and penetration rates have climbed to over 10 per cent, and as high as 28 per cent, where IPTV, in its different forms, is available.

Negatives

Mr. Ghose, whose price target is $37 with a "hold" rating, has his doubts about the BCE story. For one thing, competition in the wireless market is becoming quite intense. Start-ups such as Wind Mobile and Public Mobile are selling cheap unlimited plans that undermine the pricing power of the incumbents. Quebecor Inc. launched mobile services across Quebec last fall, one of BCE's biggest markets. And Rogers Communications expects to have next-generation wireless networks up and running in several cities by the end of 2011.

Mr. Ghose also cites the substantial cost of upgrading the fixed line network to launch IPTV - a cost he thinks has not yet fully filtered through to BCE's financial statements. These capital outlays, along with a ramp-up in spending to retain wireless customers, will likely be dilutive to earnings.

Mr. Cope sold nearly half of his BCE holdings in March to net $14-million. This could simply be prudent portfolio diversification on his part. Some observers suggest it's "another data point" that the next year or two could be tougher for BCE.

Mr. Valentini also has caveats. "Rising interest rates could take the bloom off of the rose of some of the telco valuations," he warns. Specifically, if BCE's dividend maintains its 200-basis-point premium over government of Canada 10-year bond yields, and the latter rise to 4.5 per cent by the end of 2012, as TD forecasts, then BCE's shares could trade down to $34 even assuming dividends are increased 10 per cent.

Mr. Valentini, who also has a $37 price target and "hold" rating, also draws attention to a rebound over the past year in the valuation of U.S. cable companies when compared to U.S. telcos, and sees a similar revaluation occurring in Canada.

Regulatory Environment

BCE belongs to a highly regulated industry and is therefore subject to related risks. Of note, the federal government is currently reviewing foreign ownership restrictions in the telecom industry.

Analysts generally believe Ottawa will remove the restrictions only on entrants with less than a 10-per-cent share of the market, similar to a policy the Canadian banks have lived with for many years. If so, BCE and other large incumbents should retain some market power and be able to cope with challenges from new entrants.

The upcoming 700 MHz and 2.5 GHz spectrum auctions pose another threat. But they are still quite a ways off, and even if new entrants are granted preferential terms, they will still likely face constraints obtaining foreign financing once they reach a 10-per-cent market share.

Other risks: Regulatory changes emanating from CRTC investigations into vertical integration, such as BCE owning CTV; usage-based billing; and the competitive threat from "over-the-top" services such as Netflix.

Overall, it's likely the CRTC and their political masters, the Conservatives, will take a cautious, middle road between promoting competition and preserving the strength of domestic suppliers. Indeed, Prime Minister Harper voiced a commitment to this path during the election.

(Disclosures: BCE is a parent company of the Globe and Mail and the author of this story is a BCE shareholder)

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