The Case for BCE Inc.

As reported previously, BCE Inc. (BCE/NYSE) was purchased at $23.01 per share. BCE is Canada’s largest telecommunications company. Its Bell Canada subsidiary accounts for 90% of revenues, providing traditional phone service, wireless service, Internet access and video services. Its Bell Globemedia subsidiary provides content to CTV television and publishes The Globe and Mail newspaper. Another subsidiary, Telesat, is in satellite communications.

BCE has approximately 891.4 million shares outstanding with a market capitalization of more than $20 billion. The company currently trades at 1.87 times stated book value, just over 14 times earnings and 1.21 times sales. It pays a dividend yield of more than 5%.

The company’s stock is down because of concerns over its declining legacy phone operations. These concerns are real, for BCE as well as virtually every other established phone company. In the case of BCE, some analysts estimate it will lose as much as 25% of its telephone customers to cable over time.

But BCE is pursuing strategic restructuring initiatives to extend its leadership position and boost the stock price.

Primarily, this means adding customers to its wireless, video and high-speed internet operations at a rate that makes up for losing residential landline customers. The company is therefore shedding jobs in its traditional phone unit and focusing on the growth businesses.

BCE is also rewarding shareholders through payouts and stock repurchases. The company increased its dividend in 2005 and may do so again. BCE announced its intention to repurchase 5% of its shares during the 12-month period ending February 2007.  And, with its solid balance sheet and ample free cash flow generation, look for BCE to continue paying dividends and buying back stock.

What’s more, many analysts are bullish on BCE’s management team, including CEO Michael Sabia and Bell Canada COO George Cope. And the regulatory and competitive arena BCE faces in Canada may be more favorable than those faced by its US peers, where the battlefield is more crowded.

Risks with this pick:

• BCE’s plan to replace its traditional phone customers with wireless, video and high-speed internet services users just never materializes at the levels needed.

• Pricing competition from wireless and cable phone service (VoIP) companies erodes profits.

• An unfavorable regulatory environment develops.

• Currency fluctuations.

I'm bullish on BCE as a long-term investment. But please, do your own due diligence before buying.

UPDATE 5/25/07: I trimmed the BCE Inc. (BCE/NYSE) position by 25% earlier today. The shares were sold this morning at $36.31. BCE remains a full position even after this partial sale -- being just shy of 5% of the portfolio. It still looks like BCE will get taken private. But it's prudent to take some chips off the table. Especially if the private equity boom turns out to be a bubble that gets popped before the company gets taken over later this year. That's not a prediction, but a possibility.

Comments

[Ping]

I'm also looking at BCE these days. After reading your post, I took a look again in the morningstar.com.

The Financial Strength is without questions. Total debt stood at 64% of total capital; compare to Verizon or Shaw well over 70%.

The Price to Free cash flow is around 10 times, depending on which year/normalized number one would plugged in. I think the current dividend level/shares buy-back is well supported by the ample cash flow.

However, what I don't know from Morningstar is that when the local land line decline to 75% of current level, how much that's going to affect the cash flow, as well as the margin for the new business, i.e. DSL, TV..

You didn't mention that in your post, do you have any insights on that?

[John]

Ping,

Nothing concrete. The key here is how much wireless and other growth businesses BCE generates as it loses landline residential phone customers. I'm banking on it being enough, because I think residential customers loyal to the Bell Canada brand will "naturally" use the company for wireless and/or high speed internet.

Nothing's for sure, of course.