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Hanging up on Aliant

Dave Ebner

 

TORONTO (GlobeinvestorGOLD) — Aliant Inc. is unloved by Bay Street-and the feeling isn't undeserved. The dominant phone company in Atlantic Canada, struggling with a labour strike and intense competition, doesn't have single "buy" recommendation on its stock from the dozen analysts that follow it. The group cites a variety of factors, which together produce at best a mixed outlook and provide little incentive for investors to place a buy order for a block of AIT shares.

Basically, there's no growth. Sure, that's a theme playing out across the Canadian telecom industry at all the former monopolies, of which Aliant is one. But at Aliant — which sells service in New Brunswick, Nova Scotia, Prince Edward Island and Newfoundland — the situation is more acute with sales up only 0.7 per cent in the January-March period from a year earlier.

As it struggles in the marketplace, Aliant is dealing with a strike at Aliant Telecom Inc., which generates 86 per cent of total sales. About 4,300 workers, two-thirds of the employees, have been on strike since Apr. 23, fighting for better pensions. An extended strike could result in the company losing more customers to rival EastLink, a cable TV company that also sells phone service.

Aliant has a lot of cash, around $2.50 a share, and investors want to see some of that handed back. The company has been coy about its plans, saying it first wants to look at places to invest the money in its own business to produce growth. But it is unclear what sort of growth could be generated and whether that would push the stock higher, a stock that analysts say is already expensive compared with others in the sector.

IP in PEI

The prospect of a strong wave of competition in the local phone business driven by Internet protocol (IP) technology has emerged throughout Canada and is expected to have an impact next year. This is already a reality for Aliant. EastLink, owned by privately-held Bragg Communications Inc., has been selling phone service for several years and, according to Aliant, has taken about 20 per cent of customers in a number of cities through Nova Scotia and P.E.I.

EastLink uses older circuit-switch technology to provide phone service. IP, generally cheaper to use, will likely add to the challenges Aliant is facing, said Orion Securities Inc.

"We anticipate even greater competitive pressure following the launch," said Orion analyst John Grandy in a research note to clients. Mr. Grandy estimates that Aliant will lose 2 per cent of its local phone lines annually from 2005 onwards.

"Whether Aliant can offset this revenue shortfall with further cost and [capital spending] reductions remains to be seen," Mr. Grandy said

Others say the threat from EastLink is lessening. Scotia Capital Inc. argues that "the worst may be over," but still cut its 12-month price estimate on the stock to $28 from $30 because it is unlikely the company will convert into an income trust, an idea management said this year it's not interested in.

Deregulation demands

One benefit of heated competition could be deregulation. Aliant, like other former monopolies, faces heavy restrictions in the sale of local phone service. It has to get everything approved and, among other things, can't sell a local connection in a package of other services like mobile phone and Internet. This is a disadvantage for Aliant, the company has said, when competing against EastLink.

In early April, Aliant filed an application with the Canadian Radio-television and Telecommunications Commission to stop regulating its sale of local service in 32 different areas of Nova Scotia and P.E.I., places where EastLink is competing. The application has "significant merit," said Jay Forbes, Aliant president and chief executive officer, on the company's first-quarter conference call. Analyst Greg MacDonald at National Bank Financial Inc. agrees, saying Aliant "stands a pretty good chance" of getting its application approved.

Deregulation would give Aliant far more flexibility, including the ability to raise prices to increase sales. But whether this really makes a difference for Aliant as an investment is unclear.

The declining local segment accounts for 37 per cent of Aliant's sales. Long-distance, the next largest business, is also suffering, seeing sales fall 8.6 per cent in the first quarter to $92.1-million (18 per cent of the total) from $100.8-million last year. This means more than half of Aliant's total business is shrinking. The company is also reporting lower sales in its information technology business xwave, which it tried to sell last year but failed to find an attractive offer.

Running to stand still

With bleeding just about everywhere, continuing growth in wireless and Internet — up 14 per cent and 18 per cent respectively — is enough to make up for the other declines, but no more. The end result is flat sales overall.

Profit growth is not much better, rising 4.6 per cent to $40.7-million from $38.9-million. Profit per share is rising at a quicker pace, advancing 11.5 per cent to 29 cents from 26 cents as Aliant continues to buy back its own stock.

That buyback program has been criticized by some, such as analyst Richard Talbot of RBC Dominion Securities Inc. He suggests Aliant isn't using its cash wisely, spending $180-million since last August on its own richly-valued stock instead of doling out a special dividend.

Aliant said it will continue its buyback program, a plan Merrill Lynch Canada Inc. said could help the stock in the next couple months. It traded at about $27.50 in recent days, down more than 13 per cent this year.

Divided on dividends

The dividend yield on Aliant stock in early May was about 3.9 per cent. If Aliant were to pay out two-thirds of its cash as a special dividend, about $1.60 a share, that would be close to 6-per-cent bonus for investors. But because investors are expecting something along that line already, the stock-price could well fall if a special dividend is announced.

BCE may be a factor. The Montreal-based parent of Bell Canada owns 53.5 per cent of Aliant through Bell, meaning that any money disgorged from Aliant would leave Atlantic Canada for Ontario and Quebec. This could possibly be a political concern and may be why Aliant management has emphasized that it first wants to look at investing money in its business in Atlantic Canada. (BCE has a majority stake in Bell Globemedia, owner of this Web site, The Globe and Mail and CTV television.)

Scotia Capital, which has promoted the idea that all phone companies should be income trusts, noted that BCE's majority stake in Aliant is one reason activist shareholders haven't tried to push for a trust because BCE could easily block it. BCE management hasn't indicated interest in converting larger phone companies such as Aliant into trusts.

Aliant is a compelling story as a business case study. It is the first former monopoly phone company in Canada to see what competition in the local market is like. But as an investment, it looks like Aliant management has to do too much running just to stand still, presenting few enticing prospects for those consider its shares.

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

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