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April 18, 2007

Private Equity Comes To Canada - Officially

It is now official that private equity has arrived in Canada. BCE Inc. (BCE), formerly Bell Canada, has announced that is negotiations with a group of Canadian pension funds being backed by Kohlberg, Kravis, and Roberts. KKR was the in the original stories about a possible private equity-financed takeover of BCE but the stories which broke last week indicated that Providence Equity would be the lead private equity firm working with a Canadian pension fund that is not included in the newly formed KKR group. For a more complete and Canadian perspective on the BCE story, here is an article from the Globe and Mail.

The latest news continues to drive shares of Rogers Communications meaningfully higher. RG made another all-time high yesterday, rising over 3%. The shares are now up 25% this year and 14% this month. RG is Canada's second largest telecommunications company behind BCE with whom it competes in wireless telephony and high speed internet access. RG is Canada's largest wireless company and offers the triple play as the nation's largest cable company.

My spreadsheet on RG calculates a target of $38.58 based on 10.5 times 2007 estimated EBITDA. The estimates are within RG's 2007 guidance that was announced in January. The multiple is consistent with trading levels for RG over the past year on forward estimates. Looking ahead to 2008 and assuming multiples hold and EBITDA grows 12%, my target is $45.54. It is worth noting that RG has consistently beat earnings estimates over the past year....

Investors are clearly suggesting that if BCE can be taken private so can RG. In fact, some articles have stated that RG is a better target due its much better growth profile and the recent emergence of significant free cash flow. However, unlike BCE, RG is a family controlled company. There is no way of knowing whether family patriarch Ted Rogers would be willing to sell but most observers believe he is not a seller. At least not yet.

Then again, with Providence Equity apparently shut out of the BCE deal, there is another willing entrant into the Canadian telecom industry that might look for a new deal. I've always thought the end game for RG was a sale to Comcast which has similar family ownership and would benefit from RG's wireless expertise as it will probably offer wireless services to its US customers in the next three to five years.

While I do not expect a deal for RG anytime soon, I do think the arrival of major private equity players with experience in media and telecom on our northern frontier means that RG shares have moved to a new higher multiple range. As a result, I don't think a major amount of the recent gains are likely to be given up. Should RG track at or above its 2007 guidance, I think investors will be willing to quickly look ahead to 2008 earnings and my 2008 target will be accelerated. That may take a few months but independent of a buyout, I think RG is worth holding despite reaching my 2007 target. I'd be a buyer on a pullback toward $35 or about half of his month's gains.

RG is not the only Canadian telecommunications enjoying a spurt from the BCE news. Shaw Communications (SJR) has risen over 10% this month amid speculation that it could be a seller to either private equity, or more likely private equity in partnership with RG. For some great background on SJR, here is another article from the Globe and mail discussing recent takeover speculation. The article also mentions Corus Entertainment (CJR), another company controlled by the Shaw family. CJR shares are up 12% in April.

Another potential takeout in Canada is Telus (TU). TU is a major wireless and wireline company. There has been some speculation that BCE might take a run at TU. TU would also be attractive to private equity for its fast growing wireless business. Not surprisingly, TU shares are also up 12% this month.

There is lots of activity up north beyond the Stanley Cup playoffs (Let's Go Sabres!) and traders and investors should look to RG, BCE, CJR, SJR, and TU for possible buy ideas. The telecommunications landscape in Canada is viewed favorably relative to the US due to a less fierce competitive environment. Additionally, wireless penetration in Canada is only in the upper 50% ragne, well behind the United States. Wireless started a few years later in Canada and if you plot the penetration curves of both countries based on start date, Canada is right on track with the U.S. That means that the next several years could witness the same superior growth witnessed in the U.S. in the last few years. So if you head north to speculate on the next private equity deal, you can travel knowing that the fundamental landscape is as pretty as the Canadian natural environment.

Posted by Steve Birenberg at April 18, 2007 09:19 AM in RG