Shares of Manitoba Telecom Services Inc. slumped on Friday after at least two Bay Street analysts downgraded the company's stock and urged investors to take profits.
The Winnipeg-based company's stock had risen by more than 3 per cent just one day earlier after it posted a year-over-year increase in its first-quarter profit and speculation mounted about a foreign takeover of its MTS Allstream division.
But some analysts argue the market has already priced in the possibility of a takeover of Allstream. As well, they fear pension funding could become a problem for the company next year.
During afternoon trading on the Toronto Stock Exchange Friday the company's shares were down 1.26 per cent, or 44 cents, to $34.60 after going as low as $34.32 earlier in the day. That selloff partly eroded Thursday's gains.
On Thursday, MTS's chief executive officer Pierre Blouin had mused that pending foreign investment rule changes would open the door to a range of strategic options for Allstream, including a potential takeover.
"We have long argued that the existing foreign investment restrictions in telecom limit competition and hinder access to risk capital and strategic partnerships for companies of our size. The recent federal government's announcement to relax restrictions on foreign investment in the telecom sector is good news for our company," said Mr. Blouin.
"The removal of these restrictions will expand the range of strategic alternatives available that can strengthen our business and increase value in particular for Allstream."
Beyond an outright takeover, options for Allstream could also include a joint venture, finding additional investors or tapping foreign risk capital.
Analysts, however, suggested the stock has already risen on that speculation, and recommended investors take profits.
"Despite improving Allstream trends and a real prospect for strategic activity, we are downgrading to 'neutral' from 'outperform' for two main reasons; first, the stock is up almost 20 per cent since November on the prospect of foreign investment liberalization; and second, assuming no change in rates or asset returns, pension solvency funding will again become a major headwind in 2013," wrote Greg MacDonald, an analyst with Macquarie Capital Markets Canada Ltd., in a research note to clients.
Mr. MacDonald maintained his price target of $34. He upgraded the stock last November to reflect the possibility of a foreign takeover of Allstream, noting then the division could fetch as much as $800-million.
"Without strategic activity, we think the stock would trade in the $30 range," he said.
Jeff Fan, an analyst at Scotia Capital Inc., downgraded the company's rating to "2-Sector Perform" from "1-Sector Outperform" but held his target price steady at $35.
He estimates the company's pension solvency obligation at $270-million.
"We recommend investors take profit because the easy money on MBT has been made," Mr. Fan wrote in a research note. "We would suggest waiting for the Allstream sale before re-assessing the potential upside."
He says that Allstream could likely be sold for roughly $700-million. He also noted that until Allstream is sold, concerns about risk, including its pension solvency deficit funding and dividend, will persist, especially in 2013, and could drag down the stock.
"We recommend replacing MBT with another dividend stock," added Mr. Fan. "Verizon would be our first choice on fundamentals and in Canada, RCI is a good candidate based on the recent selloff."
On Thursday, MTS reported a first-quarter profit of $53.1-million, or 80 cents a share, versus $43.4-million, or 67 cents, for the same period last year. Revenue amounted to $435.1-million, compared with year-ago $439.3-million.
Mr. Blouin, meanwhile, noted that Ottawa's plans to relax foreign investment restrictions for small telecom companies with a revenue market share of 10 per cent or less could open the door to a range of outcomes for Allstream. The rule changes are expected to be finalized in June.
Editor's note: A previous web version of this story incorrectly identified MTS's original Scotia Capital rating.