Purchase (Special Situation): Manitoba Telecom Services

Talk about picking up pennies in front of a steamroller...

The market becomes less and less attractive by the day so I'm mostly just doing research on various industries/stocks and tracking numerous special situations (mostly risk arbitrage). Even investing in mergers has become risky in my eyes because I don't have a good feeling for the new US administration. There is elevated risk of the US government blocking deals (particularly CFIUS blocking foreign deals).

I don't recommend this to anyone who doesn't invest in Canadian dollars since the returns very miniscule compared to potential currency movements. So, unless you invest directly in C$ or can hedge the fx rate, this isn't a very safe deal.

Anyway, I decided to take a position in the Manitoba Telecom Services (TSX: MBT) buyout by BCE (TSX: BCE). It's a cash and stock deal with maximum cash limit (prorated) so it complicates matters. The return is very tiny but it closes within a month. I have typically not done deals with such tiny returns so not really sure if I'm going down the wrong path here.

Deal details

BCE has agreed to buy MBT and MBT shareholders can receive: (A) $40 cash, or (B) cash+share.

Full deal is prorated so that BCE only pays a maximum of 45% in cash. This means that if all MBT shareholders choose cash, only 45% of the payment with be cash, with the remaining in BCE stock (0.6756 BCE share for each MBT share). But if only some MBT shareholders accept cash then the payment can be full cash ($40). Professional investors will have difficulty hedging this transaction since you don't know which outcome is going to materialize (although I think it is highly probable that you will end up with the cash & share option).

Shareholder votes and regulatory approvals have been granted. I consider there to be zero risk of deal not being closed. The last major regulatory approval was granted on February 15, 2017 and parties expect transaction to close by March 17, 2017.  I wasn't following this closely enough but it would have been better to invest before the final regulatory approval given how the spread narrowed significantly after that.

Current Prices (Feb 27 2017)
 $    39.17 MBT
 $    57.76 BCE

A. All cash
$40     best case all cash 2.1%
B. Cash+Stock 
0.6756     ratio
worst case if only 45% cash (if less MBT shareholders take BCE shares, can receive more cash)
 $    18.00 45% cash
 $    21.46 55% BCE
 $    39.46 0.7%

So, in the best case, where you receive 100% cash, you are looking at a return of 2.1%.
Worst case, with the proration, is 0.7% based on my calculations.

If you end up receiving BCE stock, there is risk that your return can be worse if BCE share price falls. I am not hedging by shorting BCE stock here so I'm fully exposed to potential downside in BCE shares. (Professional arbitrageurs will short BCE stock here but the possibility of cash payment makes it a bit difficult to fully hedge.)

I think 2.1% return is very attractive given the very short holding period. Even the 0.7% seems ok to me for the less than 1 month holding period. The question is whether it is worth it if BCE shares fall.

The way I look at it, I'm comfortable holding BCE shares if I end up with them. BCE is a well-run low-growth telecom/media oligopoly in Canada. Here are some key points I wrote down when I started following this deal (not necessarily from today's price): P/E 18, net profit margin 12%, ROE 22%, div 4.5%+; wide moat, low/no-growth, high ROE. I  think a P/E of 15 is more reasonable in the long-run for BCE, so this means it is probably overvalued by 20% and can easily fall by that much. This is not a bad company to hold long-term and should do ok even in bear markets or recessions (share price will obviously fall but don't think intrinsic value will decline).

Last time I got involved in a BCE special situation (LBO, in 2007 I think), the deal collapsed and I ended up losing some money. I sold the stock after deal failed but if I had kept it for an year, I would have broken even. Not saying the stock will recover the same way if it collapses, but one thing about stable high ROE companies is that they will continuously compound and make up a lot of the lost ground.

Purchase Price (TSX: MBT): $39.16


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