The Globe and Mail

Shares of telecommunications giant BCE Inc. remained deep under water early Wednesday afternoon, after plunging 40 per cent at the opening bell following a warning by the company that its massive planned privatization is in jeopardy.

The shares were trading at $25.09 on the Toronto Stock Exchange, down $13.26, or 34.6 per cent, from Tuesday's close, having earlier fallen as far as $23, or 46 per cent below the $42.75 price the would-be buyers, led by the Ontario Teachers' Pension Plan, agreed to pay in June, 2007.

The rout followed a pre-opening warning from BCE that its planned $35-billion privatization was in doubt because it had failed a preliminary solvency test conducted for the would-be purchasers.

The Montreal-based company disclosed that that it had received a “preliminary view” from auditing firm KPMG that “based on current market conditions, its analysis to date and the amount of indebtedness involved,” it does not expect to be able to deliver an opinion on the closing date of Dec. 11 that BCE “would meet the solvency tests as defined in the definitive agreement.”

Unless this changes by that date, BCE warned, “the transaction is unlikely to proceed.”

It added, however, that it is continuing to work with KPMG and the purchaser is working to satisfy all closing conditions.

Teachers' concurred in a terse statement.

“The delivery of the solvency opinion is a condition to the completion of the acquisition of BCE,” spokeswoman Deborah Allen said in a brief telephone interview. “There's no more that we can say.”

The Teachers board of directors was meeting to discuss the matter Wednesday, a source said.

BCE, which would be saddled with an additional $32-billion in debt after the leveraged buyout, is disputing KPMG's findings.

“We are disappointed with KPMG's preliminary view of post-transaction solvency, which is based on numerous assumptions and methodologies that we are currently reviewing,” BCE chief financial officer Siim Vanaselja said in the release.

“The company disagrees that the addition of the LBO debt would result in BCE not meeting the technical solvency definition.”

A spokeswoman for KPMG said the firm would not comment, citing client confidentiality.

Under the terms of Teachers credit agreement with its lenders, the banks required that BCE's auditors sign a certificate confirming that the value of BCE's total cash and assets exceeded all its liabilities, including the $32-billion of debt required to fund the takeover.

The so-called solvency test is a little known clause in banking agreements that became popular in the United States in the past decade as aggressive buyers, such as private equity funds, relied on increasingly heavy debt loads to fund their takeovers.

In telling BCE that it could not verify its solvency, at least on a preliminary basis, the auditing firm is effectively saying that the value of the company's assets had declined so significantly amid the global financial crisis that they would now be worth less than the company's liabilities if the acquisition were completed.

There has been speculation that the market rout has left BCE's pension plan so under-funded that the auditors have been unable to deliver a favourable opinion, although one person familiar with the matter said Wednesday that this is not the case.

“It's just the addition of that much debt in this capital market,” the person said.

In BCE's statement, chief executive officer George Cope noted that KPMG had also indicated that BCE would meet all solvency tests under its current capital structure.

“BCE today enjoys solid investment grade credit ratings, has $2.8-billion of cash on hand, a low level of mid-term debt maturities, and continues to deliver solid operating results,” Mr. Cope said.

In an e-mail to BCE employees, a copy of which The Globe and Mail obtained, Mr. Cope also said, “This debate over our solvency post-closing is obviously not a development we had hoped to face after such a lengthy and challenging road to privatization.”

However, Mr. Cope vowed to continue the strategy to streamline and strengthen the company and its key operating unit Bell Canada that he unveiled when he took over as CEO in mid July.

“No matter what happens next, we can and will continue our move forward at Bell with a clear goal and a focused strategy to achieve it,” he said in the e-mail. “Our . . . strategic imperatives will not change whether we are a public or a private company, and we will continue to build on the positive progress we have made to date.”

BCE spokesman Mark Langton said the company learned of KPMG's preliminary assessment after stock markets closed Tuesday.

“We disagree with the opinion,” he said in a telephone interview. “We've formulated our own set of numbers and they do not match with theirs. So we disagree with their conclusion.

“Now we have until Dec. 11 to work with them to see if they can come to a different conclusion, but if their preliminary view . . . doesn't change, then yeah, the transaction is unlikely to proceed.”

The planned leveraged buyout, the largest in Canadian history, dates to June, 2007, when Teachers, along with U.S,. investors Providence Equity Partners, Madison Dearborn Partners and Merrill Lynch Global Private Equity won BCE with a $42.75-a-share bid, worth about $35-billion in all.

The purchasing group's lead lender is battered Citigroup of New York, which the U.S, government agreed to bail out earlier this week with several hundred billion dollars in capital and loan guarantees. Citi committed to providing $13-billion in financing for the BCE leveraged buyout.

The other members of the banking group are Deutsche Bank, Royal Bank of Scotland and Toronto-Dominion Bank. The four lenders had initially planned to sell off part of the loans to other banks, but The Globe and Mail reported last week that they have delayed this until the market for such leveraged debt improves.

The banks signed on to finance the massive deal in June of last year, just before the global credit crunch descended. There has been repeated speculation in the ensuing months that they were looking for ways to bail out of the agreement. The deal also has survived several court challenges.

The latest twist in the saga startled investors Wednesday.

“We were caught totally off guard and are quite annoyed,” said David Cockfield who helps manage about $1.5-billion in assets, including BCE shares, at Leon Frazer Associates Inc. in Toronto.

Mr. Cockfield complained that “no one as far as we know had mentioned the solvency test was in the works or was required [so] it's come right out of left field as far as we're concerned.”

He also said that, on a broader scale, the turn of events further undermines investor confidence.

“It just makes you more wary of buying anything these days. If there's some uncertainty, to have it multiplied this way is quite unfortunate. It doesn't help the equity markets in general.”

Another investor, Michael Smedley, of Morgan Meighen & Associates in Toronto, said that caution requires assuming the deal is not going to take place.

Morgan Meighen manages about $800-million in assets and cut its BCE holdings in half to 100,000 shares a few months ago because of risk concerns.

Mr. Smedley called the BCE development “the highest-impact event” for the Canadian market in the current financial crisis, other than the collapse of the market for asset-backed commercial paper.

He sees a mixed outcome from Wednesday's development.

Hedge funds will be particularly affected, along with private investors, he said.

However, the stock could see some support from index-linked funds that will have to add the stock to their portfolios. The other positive would be if the company resumes paying a dividend.

Any potential link-up between Bell Canada and rival Telus Corp. is unlikely in the near term though, Mr. Smedley added.

Meanwhile, credit rating agency DBRS Ltd. of Toronto said that if the privatization does not proceed, it likely will boost its ratings on BCE and Bell Canada to a “strong investment-grade level” from the current double-B (low) level.

With files from, Jacquie McNish and Andrew Willis