Manitoba Telecom Services Inc. has completed its years-in-the-making sale of its Allstream business. So why is the market bidding up its stock like another deal is just around the corner?
The simple answer is that many investors think that MTS, free of the fibre-optic network business Allstream, is now a more attractive takeover candidate for one of the country's big telecom players. Indeed, a number of analysts who cover MTS have begun including takeout probabilities in their valuations of the stock.
But things are often more complicated than the simple answer, and a number of other analysts don't see a deal quite so likely at all. And in their view, the stock – which peaked in the weeks after the Nov. 23 sale announcement – is now trading at a price that is not justified by MTS's core, slow-growing business.
First, the Allstream deal: After failing to secure government approval for a 2013 sale of the business to an Egyptian investment firm, MTS found a more palatable buyer in Colorado-based Zayo Group Holdings Inc. The net proceeds of $420-million are actually $15-million more than the price in the failed 2013 deal, which is good, but less than the $1.7-billion MTS paid for the business in 2004, which is bad.
Also unfortunate for the company, it can be said, is that MTS will retain the pension obligations to Allstream's former workers. That exact number is not yet disclosed, but the entire Allstream plan, current and former workers together, had a $51-million deficit at the beginning of 2015.
Pension-plan costs have been a recurring issue at MTS. The company used a 2011 change in the Pension Benefits Standards Act to fund its plans with "letters of credit" – essentially IOUs from the company to the plan – rather than cash. By early 2013, the company's pension deficit was equal to roughly 20 per cent of the company's market cap, analysts at Veritas Investment Research noted. The initial – failed – Allstream sale, announced a couple of months later, was supposed to help relieve that burden.
(MTS will reveal its plans for the 2016 Allstream sale proceeds during its Feb. 4 earnings announcement; one option is to pay off $120-million in debt taken on last year to, yes, fund the pension plan.)
Jeff Fan of Scotia Capital Inc., one of five analysts who have "sell" ratings on MTS (out of 11, according to Bloomberg), says the current stock price suggests that investors are not properly considering MTS's pension obligations, which work out to $7 per share when the letters of credit are included. "The Allstream transaction has shown us that buyers do not want to assume the pension obligations," he said.
The bigger issue, however, is that there may be no ideal partner for MTS that can pass muster with Canadian regulators. Mr. Fan says he does not believe that the Liberal government, even if less restrictive than the Conservatives, will allow a national incumbent to acquire MTS's wireless segment, reducing the number of players in Manitoba to three from four. That would require another player, Toronto-based Wind Mobile, to acquire part of the wireless business, he says, not long after Wind exited Manitoba by selling to MTS.
Sanford Lee of Canaccord Genuity Corp. is more optimistic about the takeover possibilities, but he notes that spectrum concentration is another hurdle, and any of the telecoms would exceed regulatory limits on spectrum ownership by buying MTS.
And the good old-fashioned "wireline" business would see reduced competition as well if BCE Inc. or Telus Corp. was the buyer, Mr. Lee says. "We are not so sure that regulators would be quick to approve a deal that reduces business and wholesale telecom options in wireline, in addition to reducing choice in wireless."
(Rogers seems to be out of the picture, as its 33-per-cent wireless share in Manitoba, added to MTS's 51 per cent, would be an unpalatable level of control of the province's market.)
Meanwhile, analyst Desmond Lau of Veritas Investment Research says he is not sure that MTS is worth the bother for BCE. Mr. Lau figures that after BCE paid the extra dividends required from a deal-related share issuance, MTS would add about $39-million to $69-million in free cash flow, a boost to BCE of just 1 per cent to 2 per cent.
These are, certainly, the downside views; by contrast, Vince Valentini of TD Securities Inc. says he places "high odds" of a 2016 takeover of MTS, and his "base case" takeover value is $36. His target price of $32 is based on a 50-per-cent probability of that happening – but, also, a 50-per-cent weighting to his "fundamental" MTS value of $28 per share. That's below Wednesday's closing price of $28.99, which means that investors who buy now have to hope that one of Canada's big telecoms finds both a reason and the means to make an MTS deal work.