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More on Bell Bonds

LBO debt fears hammer BCE bonds

CATHERINE MCLEAN

Globe and Mail Update

April 25, 2007 at 10:30 PM EST

For BCE Inc.'s nervous bondholders, a private equity buyout is something to dread, not cheer.

While takeover reports have sent BCE shares surging in recent weeks, those holding its debt have only seen their worries mount as prices for BCE and Bell Canada bonds slide.

"The stock may have gained billions, but the bonds have lost billions," said Jacques Pr?vost, first vice-president of global fixed income at CIBC Asset Management, which holds Bell bonds.

Long-term bonds have been hit particularly hard. One issue, maturing in 2035, has suffered a drop of almost 20 per cent in face value in the past five weeks. This while the stock has risen by a third to touch $40.

Uncertainty about BCE's future has sent tremors through the Canadian fixed-income market as some Bell bonds that once traded at investment grade levels slip toward junk bond territory, according to Mr. Pr?vost.

This kind of situation typically occurs when there are serious concerns about a company's financial outlook. The difference here is that BCE is not facing any financial difficulties.

Instead, bondholders are fretting a private equity firm could snap up BCE, take it private, and load up on debt. The credit ratings for BCE and its main Bell unit could then fall below investment grade because of the greater risks that come with a more leveraged company.

"This is probably one of the biggest events to ever hit the Canadian bond market," said Jack Alvo, assistant vice-president of Canadian credit at MFC Global Investment Management. "This is the first time a company of the size of Bell has become an LBO [leveraged buyout] target, and that has resulted in really a big hit on the price of the bonds."

"Bondholders always live in fear they're holding bonds of a company that all of a sudden is an LBO target," Mr. Alvo added.

Until recently, BCE and Bell bonds were unexciting but reliable investments. The headaches for bondholders began late last month, when reports surfaced that New York-based private equity giant Kohlberg Kravis Roberts & Co. was circling Montreal-based BCE.

Then came an announcement from the Ontario Teachers Pension Plan that it was becoming an active shareholder, and was considering taking a run at BCE.

Last week, BCE confirmed it is in talks with a group that included Canadian pension funds and KKR about a possible privatization.

In response, DBRS Ltd. and Moody's Investors Service quickly placed BCE's and Bell's credit ratings under review. Both agencies warned that a buyout and any subsequent increase in debt could lead to non-investment-grade ratings, a dramatic reversal of fortune for the Canadian blue chip.

Such a shift would pose a significant problem for many portfolio managers who are restricted to holding investment-grade debt.

"All of these bonds were good-quality, investment-grade bonds," explained Zaheer Khan, vice-president of corporate investments at Baker Gilmore & Associates Inc. "These were the main staple of many, many asset managers."

For now, the best that BCE and Bell bondholders can hope for is that the company redeems their bonds if there is a takeover.

That's what occurred when a group including KKR bought Denmark's biggest phone company, TDC A/S. Debt holders were able to sell their bonds back at 99 per cent of face value.

Nevertheless, fixed-income portfolio managers and rating agencies agree the future is unclear.

BCE and Bell bonds have been issued under three different sets of terms or covenants from 1976, 1996, and 1997, and some offer greater protection than others.

"Depending on the structure of any such transaction, DBRS notes that there is a potential all or some of the company's bonds could remain in place and subject to a significantly higher financial risk profile," DBRS analysts wrote in a note last week.

A BCE spokesman declined to comment. (BCE owns a minority interest in CTVglobemedia Inc., the owner of The Globe and Mail and CTV television network.)

Over all, the number of protective covenants for bondholders has been slipping in recent years, Mr. Alvo said. However, with private equity buyouts on the rise, including a possible BCE takeover, there are growing calls for change.

"This is the type of thing that could shake the market, and it really should lead to future bond issuances being done with better protection for bondholders," Mr. Alvo said.



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