In early August, ratings agency DBRS Ltd. downgraded BCE Inc. (TSX:BCE)(NYSE:BCE) and Bell Canada, its operating business, suggesting the company would take longer than expected to get its net debt down to between 1.75 times and 2.25 times EBITDA, its target range, from its current level of 2.50.
“Successive, largely debt-financed acquisitions in recent years have caused the company’s financial leverage to remain above its stated target … and have repeatedly delayed the company’s deleveraging plans,” stated DBRS in its August 8 statement.
To be specific, BCE has spent $11 billion over the past three years acquiring Bell Aliant, Astral Media, Manitoba Telecom Services, and its most recent pickup, a $675 million deal to buy the remaining 65% stake it didn’t already own in Q9 Networks, a leading data centre operator.
As a result of these deals, BCE’s net debt sits at $21.7 billion as of the end of June with $8.7 billion in adjusted EBITDA over the trailing 12 months. While BCE’s leverage ratio is higher than its targeted range, DBRS is quick to point out that it’s still lower than both Telus Corporation and Rogers Communications Inc., whose net debt is 2.7 and 3.1 times EBITDA, respectively.
So, if these three companies were crack addicts, BCE would be least likely to need hospitalization or rehab. Investors shouldn’t find that comforting.
Don’t get me wrong. I’m all for companies investing in their businesses because that’s the only way to grow, but it seems that investors are being far too easy on the company for its “suck and blow” routine. While borrowing heavily to improve its technology, investing in wireless spectrum, and acquiring other businesses, it’s also returning capital to shareholders, leaving less in the kitty for the repayment of its ever-higher debt levels.
Strung out and looking for a fix, it announced a $1.5 billion debt offering at the same time as the DBRS downgrade in August. “With this transaction, we are pleased to have secured significant debt capital at what is the all-time lowest financing rate ever achieved by Bell Canada on any [medium-term note] debenture issuance,” BCE CFO Glen LeBlanc said in a statement. The company will use the funds to pay for the Q9 acquisition, retire debt due in February, and for general working capital.
BCE’s long-term debt over the past decade has ranged anywhere from 26% of total assets in 2008 to 36% in 2013. Today, it’s around 33% and rising. If interest rates move up, BCE is going to have to allocate more of its free cash flow to debt repayment and less to acquisitions, dividends, and share repurchases.
However, what happens if BCE’s business doesn’t deliver the $9 billion in annual pro forma EBITDA (after dividends) DBRS expects it will do in the near to medium term? Its current free cash flow is less than 5% of its total debt. That means it would take the company 20 years to pay down its entire debt. Dividends would still get paid in this scenario, but acquisitions and share repurchases would have to be put on the back burner.
I’m not trying to scare BCE investors, but when I read headlines that suggest blue-chip stocks are a sure thing in terms of dividends and steady growth, I have to wonder how closely some people are looking at the balance sheets of these companies.
If it makes sense to pay off 100% of your mortgage, why shouldn’t BCE to do the same? If it doesn’t do a better job of lowering its leverage, investors could wake up one day with a bad case of indigestion.