Canada's biggest telephone company turned its back on a quarter-century of attempts to diversify yesterday when it unveiled plans to turn its main asset into an income trust.
The elimination of BCE Inc. and creation of the Bell Canada Income Fund will allow the Montreal-based company to complete a return to its roots in telecommunications services.
"There's no doubt that the winding down of BCE certainly does mark the end of an era in Canadian business," Michael Sabia, chief executive officer of BCE and its Bell Canada division, said yesterday.
"BCE was a company created for another time with objectives that were very much about diversification, and very much about diversification away from Bell," he said. "Our strategy has been different. Our strategy has been all about focus -- focus on Bell."
While the change may signal an end to BCE's diversification adventure, it could create a new political headache for Ottawa. BCE is the largest company that has converted to an income trust so far. Under the new structure, Bell, like other trusts, will pay minimal corporate taxes because it will distribute most of its cash to unitholders.
In Vancouver, Finance Minister Jim Flaherty was tight-lipped about the implications of trust conversions on the federal treasury.
"As I've said before, I won't comment on any particular conversion or proposed conversion involving any particular corporate entity in Canada. But we do remain concerned and continue to monitor the situation," he said.
Mr. Sabia's move marks the end of a strategy developed in 1982 by A. Jean de Grandpré, who was then chairman of Bell Canada. BCE was created as a holding company out of the old monopoly utility as part of an attempt to ensure its non-telephone enterprises would be free from the clutches of the telecom regulator.
In the ensuing years, Mr. de Grandpré and his successors at BCE assembled a stable of assets that included household names such as Northern Telecom Ltd., which it had already controlled, TransCanada Pipelines Ltd., and Teleglobe Inc. But some of those investments, which also included real estate, financial and computer services, led to massive writedowns and BCE gradually began shedding them.
After that disappointing experience, investors didn't want to see BCE stray far from its main business.
Mr. Sabia, who took over in April, 2002, spent his first four years selling off non-core assets. The income trust caps the shift from diversification to one-industry focus, Mr. Sabia said yesterday.
"The main thing that's been of concern to us is focusing on the core business, and getting it to perform at the level where it should," said Brian Gibson, senior vice-president at the Ontario Teachers Pension Plan, a major BCE shareholder. "It's been quite a challenge because that whole industry has been changing rapidly."
Investors clearly like trusts. Shares in BCE, stuck in neutral since 2002, had gained 15 per cent in the past month on speculation the company would follow Telus Corp. and convert to a trust. The stock gained $1.37 to $32.92 yesterday on the Toronto Stock Exchange.
BCE shareholders, whose approval of the transaction is required, will receive one unit in the new trust for every common share they hold. Their annual cash distribution will rise 93 per cent to $2.55 per unit from BCE's current dividend of $1.32 a share.
Nevertheless, the phone company is leaving any dreams of growth behind it, one observer believes.
"To some extent, it's throwing in the towel in terms of Bell's long-run vision," said Laurence Booth, a finance professor at the University of Toronto's Rotman School of Management.
"The big change is essentially the retreat from these grandiose plans of the late 1990s that would involve the development of a telecommunications-media convergence of technology into a core business with the cash flows being returned to stockholders."
Mr. Sabia acknowledged that Telus was a factor in BCE's decision, though the company had been pondering such a move for months.
"I don't think in an industry like ours you want to see a significant difference in the cost of capital between Telus on one hand, us on the other hand," Mr. Sabia explained yesterday in an interview.
A higher cost of capital could make it more difficult for Bell to compete, observers believe. Cost of capital can affect a company's ability to raise money and make acquisitions.
Converting to a trust could also help protect Bell against takeovers, some observers suggested. "By converting to a trust, they do have a higher price," said Leslie Lundquist, a portfolio manager at Bissett Investment Management, who doesn't hold BCE shares. "There is a school of thought that would say part of the reason they converted is to make sure they didn't become a target of Telus."
A key reason phone companies are converting to income trusts is to slash their tax bills. Income trusts distribute most of their cash to unitholders, who in turn pay taxes on the distributions. Tax shelters BCE had enjoyed were due to expire by next year, which means a $250-million tax bill for 2007 would balloon to $800-million for 2008, according to the company.
Still, questions remain about how such a structure will affect the ability of phone companies to invest in their networks in a very competitive industry. Cable companies have successfully rolled out phone services, while carriers like Bell are only in the very early stages of countering with TV service over their copper wires.
BCE, like Telus, insists its plans will leave it with enough money so that it has the flexibility to make future investments. It expects the new trust to pay out 85 per cent of its cash after capital expenditures.
"The leadership of both these companies going forward will have to be mindful they will still need to make the requisite big investments in the business that have been needed for a century," IDC Canada analyst Lawrence Surtees said. "Whether it's Internet, wireless, land line or the telegraph, these businesses consume massive amounts of capital."
Mr. Sabia's route to the Bell trust was far from direct. In February, the company announced plans to put its rural phone lines into an income trust. A month later, it added the land-line assets of Aliant Inc., the Atlantic Canada phone company it controls.
BCE's board advised shareholders at June's annual general meeting to reject an investor proposal to convert all of Bell into an income trust. Mr. Sabia said the situation has changed since then, citing progress in cutting costs and winning back customers.
Although the company's focus is on Bell, it plans to keep some souvenirs from its shopping spree. They include its minority stake in Bell Globemedia, owner of The Globe and Mail and the CTV television network, along with an investment in Telesat Holdings Inc.
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