Private Equity Targets Telecoms

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Some of the factors driving Ontario Teachers' interest in BCE are specific to the situation. BCE wanted to take advantage of a tax loophole popular with many Canadian companies for the last few years by converting itself into an income trust.

Income trusts own many smaller Canadian companies. That has allowed them to avoid paying corporate taxes on distributions to the trusts, as long as those distributions are within certain limits. The Canadian government, concerned that it is losing tax revenue, has put an end to the game. The prospect of larger companies such as BCE turning into trusts led to tax reform last fall. Ontario Teachers may be compelled to own BCE directly so it can control costs more closely in a tighter regulatory and tax environment.

Appealing Growth Prospects

Private equity's interest in telecom goes beyond the Canadian tax issue, of course. Alltel has hired investment bankers to explore strategic options for the $22 billion company (see BusinessWeek.com, 12/29/06, "Private Equity Reportedly Circles Alltel"). Private equity firms are considering a buyout, investment bankers say, attracted by the company's growth and profitability. The main sticking point is price. With an M&A premium already figured into the price, buyers are concerned that they could overpay and undercut their returns. Verizon Communications (VZ), which uses the same wireless technology as Alltel, could also compete with private equity firms for the company.

Sprint Nextel is considered a potential takeout target, even though its market cap is a dizzying $57 billion. It has long been the subject of rumors of that Comcast (CMCSA) and other cable TV operators will acquire it. But a report in March by Goldman Sachs' (GS) Jason Armstrong and Scott Marchakitus said that Sprint Nextel could make an attractive LBO, especially if operating results were to improve 10% or so above forecast (see BusinessWeek.com, 3/23/07, "Why $80 Billion for Sprint May Make Sense"). Including debt and a takeover premium, the total price of a buyout could be more than $80 billion. That would be nearly twice as large as the pending $45 billion record takeover of energy company TXU (TXU).

Qwest would be a more affordable purchase. The Denver phone company has a market cap of $17 billion, up in recent years as the company has fought back from scandal. It has little in the way of wireless operations and its region is less attractive than either of the coasts, but its cash flow is strong enough to attract private equity interest.

None of the acquisitions are certain, of course. But the idea of a multibillion-dollar telecom buyout has gone from unthinkable to likely. A few years ago, it was the telecom giants that were making the major purchases in the sector. Now the balance of power seems to be shifting to private equity.

Rosenbush is a senior writer for BusinessWeek.com in New York.