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Telus has a history of rewarding shareholders with dividend growth, according to Yield Hog panelist Tony Demarin of BCV Asset Management.SHAUN BEST

Telus Corp. is caught in a fight between two opposing groups of hedge funds, and the biggest casualty may be the company's plan to collapse its two-class share structure.

Telus non-voting shares in recent months generally traded at a discount of about 5 per cent, or an average of about $2.50 a share, to Telus voting shares. So when Telus said last month it would do a one-for-one swap of the non-voters for the voters, it left an opening for hedge funds.

The easy win was to short voting shares, buy the non-voters and wait. When the swap happened, you could hand in your non-voters and get back voters, then close out the short position and keep the $2.50. Let's call that the plain-vanilla trade – because it's a basic play in a situation like this.

As funds put on the vanilla trade, the result of the shorting of voting shares and the buying of non-voting shares pretty much erased the historical gap between the share prices of the two classes.

What Telus and the first bunch of arbitrageurs weren't counting on was a second group that saw another opportunity at this point. If this second group could buy enough voting shares, they could stop Telus's plan to swap the non-voters for voters. That's because the exchange was subject to shareholder approval. At that point, the gap between the shares would likely widen out again.

So the second group put on the exact reverse of the vanilla trade. They waited until the gap closed, then shorted the non-voters and bought the voting shares.

The buying of voting shares by hedge funds, most of whom are outside Canada, pushed Telus up against restrictions on the amount of its voting stock that can be held by non-Canadians. Under federal rules, telecom companies are not allowed to have more than 33.33 per cent of their voting shares in foreign ownership.

It also started bringing back the gap in the value between voting and non-voting stock. As that took place, some in the first group bailed out, widening the gap even more. The second group had another way to push the share prices further apart. As owners of Telus voting shares, they could say "No" to people trying to borrow the voting stock and short it to put on the vanilla trade.

By Thursday, the non-voting shares were 87 cents lower than the voting stock and the gulf was steadily widening.

With some estimates that hedge funds that are against the swap now hold as much as 20 per cent of Telus's voting stock, the company faces the very real possibility of the share-exchange failing. If one-third of shareholders who vote are against it, the plan to enfranchise a group of shareholders will fail.

"It's unfortunate that we have a situation where people, hedge funds ... with minimal or no economic interest, concern (or) care for the governance, the operations or anything to do with the company, other than playing the spread between two classes of shares, can attempt to derail a process which is inherently one that is consistent with the best of good governance," said Telus chief financial officer Robert McFarlane.

"So in that sense, there is a concern because this is good governance versus hedge funds trying to make short-term trading gains."

The key will be the turnout for the shareholder vote on May 9. If shareholders in favour of the exchange don't vote, the anti-swap hedge funds could triumph.

"There is a realistic possibility that they block it," said Rick Meslin, head of equities and chief executive officer of UBS Securities Canada Inc.

Mr. McFarlane dismissed speculation that Telus could try to offer a compromise by changing the share-exchange ratio to please the hedge funds that have positioned themselves against the one-for-one swap.

"It is not negotiable. The company, the board, has no interest to consider any other consolidation ratio other than one-to-one," he said.

If the company loses this time, it will simply try again.

"We'll make it happen at another time," Mr. McFarlane said. "This issue is not going away."

With files from reporter Rita Trichur