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Remaking BCE

Dave Ebner

TORONTO (GlobeinvestorGOLD)—Michael Sabia is remaking BCE Inc., returning the communications conglomerate to its roots as the classic Canadian blue chip. After several years of tumult, BCE is once more worthy of a cornerstone position in Canadians' portfolios, the type of holding that delivers reliable price gains and dividend income for years ahead.

"We believe BCE offers investors excellent long-term potential returns, approaching the 17 per cent compound average return it has achieved over the past 20 years," said John Henderson, a Scotia Capital Inc. analyst, in a recent 34-page report lauding the Montreal company.

BCE over three years"Clearly , this has not been the experience over the past three years; nor was it during the early 1990s [recession]," Mr. Henderson continued. "However, we believe the stock is well positioned to return to attractive levels of return for investors."

Don't get too excited. Seventeen per cent-which includes reinvested dividends and profit from the sale of Nortel Networks Corp.—is a reflection of the 1982-2000 bull market. Still, investors can confidently and conservatively define an "attractive" return at around 9 per cent annually.

That is, by Mr. Sabia's aim from last November, a couple of percentage points better than Canadian gross domestic product plus a dividend yield of around 4 per cent. Nine per cent looks just okay, sure, but when investing gurus such as Warren Buffett et al. say the broader stock market's going to return 5 to 7 per cent a year in the decade ahead, BCE sure looks blue.

There are several compelling reasons to take a position, some analysts and investors say, beginning with the company's dominant position in the Canadian telecommunications business, an unmatched portfolio of products and a management team steeling the company for a competitive onslaught.

Before moving further, however, a key disclosure: BCE controls Bell Globemedia, owner of The Globe and Mail, GlobeinvestorGOLD.com and Trade by Numbers.

Losing its way

In 2000, BCE's strategy veered off course, trying to generate double-digit growth while distracted by some boom-era beliefs that ultimately proved empty. BCE management was unimpressed with the potential of its key asset, Bell Canada, the country's largest telephone company. Looking elsewhere, it took full control of international phone company Teleglobe Inc. and bought television network CTV, eventually creating Bell Globemedia when it added The Globe and Mail newspaper and its affiliated websites.

The strategy was one of convergence: melding Internet services and content. The deals cost more than $10-billion.

Teleglobe, however, went bankrupt, prompting the resignation of former BCE head Jean Monty in April, 2002. Mr. Sabia took over and immediately reversed BCE's direction. While Bell Globemedia remains a part of the company, it is not considered core and many observers reckon it will be sold when the price is right.

Boring old Ma Bell was, and remains, Mr. Sabia's focus.

But he first had to deal with the $6.3-billion buyback of the 20 per cent of Bell Canada that BCE sold in 1999. Raising the cash dominated last year's focus but BCE pulled it off, completing some of the largest equity and debt deals in Canadian history, a significant vote of confidence from investors in Mr. Sabia's.

Back to basics

Canadian National Railway over three yearsBell Canada, a decade after it faced the first blast of unfettered competition, still looked very much like a lumbering monopoly when Mr. Sabia turned his attention to the real matter at hand. The seasoned executive and former top-ranking government official helped remake Canadian National Railway Co. in the 1990s and set out to reinvent Bell.

It's easy to pick at the problems. Local access sales-your basic telephone connection-has been declining. The situation isn't as bad as that facing phone companies in the United States but is disturbing enough. Revenue from long-distance, another one-time cash cow, is also sliding badly.

Impressive growth in mobile telephony, Internet and satellite television hasn't made up the difference. That leaves, for now, overall sales in decline, a fact also blamed on government regulatory decisions and the sale of the profitable Yellow Pages directories business.

"BCE has to run hard just to stay where it is," commented Neeraj Monga of Veritas Investment Research in a recent report.

Unlike managers in the past, Mr. Sabia is readying Bell to unleash its full potential, which should produce significant forward momentum after the present period of stasis.

The company has been reorganized, discarding anachronistic geographic divisions in favour of a "customer facing" setup, dividing the company into three parts: consumer, small and medium businesses and large businesses. This reorganization underpins the emerging effort to sell as many products as possible to the same customers.

"We see this move as a precursor to a potential future consolidation of BCE and Bell Canada into a single organization, a move which we believe investors would welcome," said Glen Campbell, an analyst at Merrill Lynch Canada, after the announcement. "These changes—should help in the longer term."

In Canada, only BCE can currently deliver local telephone, mobile telephone, television and Internet services, four things many observers say will comprise a standard package deal within a couple years. The cable TV companies are moving towards offering fixed-line telephone. But as opposed to what's going on in the U.S., the domestic cable TV companies are way behind-handing BCE a great advantage.

The company has an established network and a clear vision of the future, already prepared for competitive attacks while trying to devise something new and creative. Mr. Sabia promised some "pretty interesting" new offerings this fall and the goal on a three-to-five year scale is "substantial amounts of growth."

So-called disruptive technology-such as voice service online using Internet protocol-is another threat but also presents promise. Bell is the one everybody wants to unseat yet under the watchful eye of systems and technology president Eugene Roman the company is quietly joining the IP future many in the industry predict will eventually dominate.

No Canadian company is better positioned for the major changes about to hit telecommunications. And, for the first time in two decades, BCE is totally focused on Bell Canada.

Valuation and the CRTC

Analysts expect BCE to earn $1.96 a share this year, just above the company's stated target range of $1.85 to $1.95. A buck a share has already been made in the first six months of the year. The stock fell in early August, reacting to news out of the second-quarter results that the outlook for business spending in the next couple months is not good. With the stock dancing around $30 in early August, it's valued at 15 times this year's profit estimate, basically the standard long-term valuation for the broad market.

There's no blow-out growth coming, but as one should expect of a blue chip, the prospects for steady growth-and dividend increases-are there.

Finally, a note regarding the Canadian Radio-television and Telecommunications Commission, the federal regulator. The commission in its decisions this year has constantly favoured small competitors fighting to win a sliver of Bell's business. This can be characterized as a minor irritant at best. The real competitive concern is players such as cable TV company Rogers Communications Inc. and the potential opening of the Canadian telecom market to foreign competition.

Again, BCE appears ready. Bell faces a market unlike any its ever seen in its century-plus history, but finally shaking off monopoly-era cobwebs it is poised to not only perform but prevail.

Dave Ebner writes about phone companies and network equipment makers for The Globe and Mail's Report on Business.

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