Last Friday, May 22, Ontario Teachers' Pension Plan (OTPP) quietly sold much of its stake in Canadian Bell (BCE Inc.) thus ending the tumultuous relationship between the institutional investor and Canada's largest telecom company. For BCE, there had been 18 months of buyout-related distractions, including regulatory hearings, near-constant pressure from cash-strapped banks, a bondholder lawsuit that went all the way to the country's highest court, all of which took a toll on the company's competitive position. More on that aspect of the story in part two.
At the credit boom's peak in June 2007, OTPP and three private equity firms, including Providence Equity Partners and Madison Dearborn Partners agreed to buy BCE, including all outstanding debt, and accounting for currency fluctuations. In January 2008, OTPP proposed a $52 billion takeover of Bell Canada. The buyout was to be the largest leveraged buyout in Canadian history and possibly of the world.
OTPP was to be the bond holder of $33 billion of debt after the cheering stopped. Bondholders are the folks who bought up Bell Canada's highly rated telephone bonds with the understanding they would gain in value over the life of the bond.
By Spring 2008, the proposed buyout was starting to have problems. From January to June, the deal had been in front of the Supreme Court of Canada who finally gave them the go ahead. A question that remained unanswered until December 11, 2008 came from Supreme Court Justice Ian Binnie who asked both sides: “How can it be in the interest of the corporation to load it up with debt?” The judge was asking a variation on an old business question: How does any company buy up another company and not get a belly ache? It is widely accepted that merging two companies is never easy. Accenture is a specialist studying this problem. They have over twenty years' experience and have looked at over 400 mergers and acquisitions.
Accenture agrees with a February 2003 Harvard Business Review article which says the results for an acquisition are determined by what is set up at the beginning. The biggest factor which leads to failure is cultural differences between the companies.
The same Harvard Business Review article says that in the first year of a merger or acquisition nearly 25 percent of the executives and other talented employees leave – three times the rate for a similar company without a merger. In the second year, an additional 15 percent leave, which is twice the normal rate. This high departure rate continues for up to nine years after a merger or acquisition.
During Spring 2008, OTPP and their partners were still negotiating with banks for financing after the banks tried to tighten their financing terms. Citigroup, Deutsche Bank, Royal Bank of Scotland and Toronto-Dominion Bank, were the four banks that had committed to financing the debt portion of the largest leveraged buyout deal. In a jointly issued statement they then said they still backed the proposed sale. Later in Fall of 2008, these were the same banks that received “bailout money” from their countries' government.
Citigroup's November bailout money, the US Treasury's Troubled Asset Relief Program (TARP) funds, seemed to give a surge of confidence that the $52 billion takeover of Bell Canada would close on schedule in December 2008. Of the $33 billion of debt being used to finance the buyout, Citigroup was responsible for about $11 billion (USD). By then the subprime mortgage crisis and credit crisis was in full swing which had all but frozen the secondary market for leveraged debt. Last fall, the four banks that agreed to finance the deal were then thought to have planned to keep the debt on their balance sheets.
About the same time as the Canadian surge of confidence from the Citigroup bailout money helping the OTPP – BEC deal, hidden forces were at work.
Unbeknown to the crowds in the street cheering the deal on along came the auditing firm KPMG with a very unfavorable opinion about the transaction's so-called solvency test. The deal's debt and market conditions were working against it. It was the same sort of problem Canadian Supreme Court Justice Binnie had foreseen over half a year earlier. The largest leveraged buyout in history's house of cards came crashing down on Thursday December 11, 2008.
George Cope, the chief executive of Bell Canada's parent, said that no one on the phone company's deal team, including an army of high-priced lawyers, had ever raised a flag about the transaction's so-called solvency test prior to November 26. That was the day BCE revealed that accounting firm KPMG had delivered an unfavorable opinion that effectively killed the deal. BCE had actually hired a second auditor, PricewaterhouseCoopers, in an attempt to gain an endorsement for the deal and influence KPMG's final opinion on the matter. That brings into question some of the official statements by BCE's CEO.
Then there is BCE's demand that the buyout group, led by OTTP, pay the phone company the deal's $1.187 billion “reverse breakup fee” because of a termination notice that was delivered to BCE "prematurely." OTPP on the other side doesn't believe any break fees are owed because the deal failed on KPMG's solvency opinion. The independent auditor's solvency test opinion was a condition to which both sides had originally agreed upon.
At the end of 2008, BCE was the single largest holding in Teachers' $80.16 billion portfolio. The pension plan had a 50.8-million-share stake in BCE worth $1.19 billion, but in its last regulatory filing as of March 31, 2009, the stake had shrunk to 39.8 million shares. When the deal was first signed in June 2007, BCE was selling at $39.20 per share. Friday, May 21 OTPP BCE shares sold for $21.09 each, approximate return was $839,382,000.
So did the Canadian Supreme Court Justice have a better crystal ball than the lawyers when he asked about all that debt? Maybe he read that February 2003 Harvard Business Review article. Or could it have been simple skepticism based on years of adjudicating business cases? Either way when a deal gets really huge, like the largest leverage buyout in history, all your problems tend to grow exponentially.