Saturday, August 9, 2008

Jarislowsky Blasts the BCE Deal


The good thing about being an old, wise, extremely successful and wealthy money manager is that you do not have to pull punches when criticizing anyone or anything (the same goes for a younger, intelligent and independent investment analyst that has absolutely nothing to lose by using publicly available information to expose the games that some pension funds play).

Diane Francis posted her interview of legendary billionaire investor Stephen Jarislowsky of Jarislowky Fraser on her blog in the Financial Post. The topic was on the world's biggest leveraged buyout, the Bell Canada (BCE) takeout by a couple of U.S. private equity funds and the Ontario Teachers' Pension Plan.

Ms. Francis notes that this deal has been "hugely controversial and questionable" given that BCE bondholders were "skinned alive" as they lost court battles to stop the deal from going through:

Shareholders approved a deal to close in June which didn't and, even so, new owners have started to tear the place apart and stop dividends.Ontario Teachers' ownership exceeds the 30% limit on pension ownership and the American equity participation exceeds the 25% limits on telecom ownership.

As you read below, Mr. Jarislowsky certainly does not mince his words when condemning this deal:

Q: BCE?
A: “It’s outrageous that the board of directors took $1 billion from BCE’s bondholders. It’s also just plain stupid that the Supreme Court of Canada, in a 7 to 0 opinion, briefly heard the case and overturned the Quebec Appeal Court’s unanimous 5 to 0 opinion upholding the rights of bondholders.”

Q: The Supreme Court’s overturning of the Quebec Appeal Court’s unanimous decision in any other issue would have sparked a constitutional crisis? What was this all about?
A: “The whole field of investor law is a joke in Canada. What was allowed to happen to BCE bondholders is unbelievable. The dividends were cut for BCE shareholders to reduce the price paid. The board did not look after the bondholders as well as the shareholders. The Quebec Appeal Court’s decision was the correct one.”

Q: Wasn’t this lack of protection for bondholders in the fine print of the deal?
A: “In Canada, the board is responsible to the company and not the shareholders or bondholders. Thomson Reuters just sold bonds and had a clause which stated that bondholders were not protected or subordinate to shareholders. We would not buy bonds like that which mean that they can go from As to junk based on board decisions in the future.”

Q: How is it that BCE is now run by the buyers even though the deal hasn’t closed?
A: “It’s unacceptable.”

Q: Will BCE get the debt it needs to close the deal?

A: “I don’t know. The banks have been out of control and are now having difficulties.”

Q: What legal reforms should occur in Canada?
A: “Much work needs to be done and I am setting up a foundation with others to come up with legislative ideas. Take Conrad Black. He stole more money in Canada than he did in the U.S. and he wasn’t even pursued here. We do not have police or securities commissions who are on the ball. We do not have specialized courts who understand what to do. Suing in Canadian courts is not a remedy because it takes ten years to get anywhere and why should shareholders have to suffer when a board has done something wrong?”

“Arbitration, not lawsuits, is the best way to handle disagreements and problems.”


Q: Why has BCE been so badly managed for so long?

A: “All the company did for decades was go to Ottawa and ask for higher rates of return. They blew money on bad investments and never fixed their customer relations problem. This is a company that has been disliked as much as Air Canada with its hated, high-handed employee behaviour toward customers. That still hasn’t been fixed. I used to have lunch with Michael [Sabia, former CEO]. I like him but he never fixed it.”

Mr. Jarislowsky is absolutely right. In my discussions with Diane Urquhart, the current regulatory environment and the legal system in Canada are woefully inadequate to handle securities crime and complex securities issues. Ms. Urquhart has fought her own battles with directors and is well aware that gross incompetence and negligence plagues many boards here in Canada. She has fought for investors' rights on income trusts and more recently she has taken on the big banks and pension funds to fight for the rights of small investors that lost millions in the Canadian asset-backed commercial paper (ABCP) debacle.

My own experience consulting the Special Investigations Unit at the Canada Revenue Agency on mitigating white collar crime in Canada taught me that a lot more needs to be done to protect small investors from fraud and mismanagement of funds. That was over eleven years ago and virtually nothing has been done since then to beef up laws and regulations to protect investors from fraud and abuse.

The BCE deal is just another example of outrageous abuse. The bondholders got royally screwed and the Supreme Court of Canada set a very dangerous precedent. (If you are an investor who holds AAA corporate bonds, you better familiarize yourself with "event risk".)

More importantly, I have serious concerns about how Ontario Teachers and their private equity partners will make money on this deal. As I have written before, the fundamentals in private equity and other private markets are terrible. Given the enormous debt financing of the deal at a time when the credit crisis is far from over, there are serious risks that Teachers and their partners will lose big on this deal. (PSP Investments and the Caisse de dépôt et placement du Québec were wise enough to walk away from the deal).

Despite the fact that the deal has not been closed, the buyers have cut the dividends and fired a bunch of BCE employees. This is totally unacceptable and it proves to me that they have not thought things through carefully. Ontario Teachers' stakeholders should be concerned about these unfolding events because the risks of this deal are grossly understated.

Finally, I am concerned that large public pension funds who forged ahead allocating billions into private equity, real estate, infrastructure, hedge funds, commodities, timberland and other "exotic alternatives" are going to get a rude awakening. These investment activities were touted as being "important diversifiers" when equity markets turn south but they increasingly look like a giant bubble that is imploding fast (especially private markets).

The problem is that the damage is done. As I have stated in previous posts, most of these "alternative investments" are governed by bogus benchmarks that do not reflect the risks and/or beta of the underlying portfolio, allowing some public pension fund managers to reap millions in bonuses. Worse still, the Board of Directors which are suppose to act as independent guardians, praise these managers for "outperforming" some composite benchmark which includes these bogus benchmarks (it's truly pathetic!).

Do we need a massive overhaul of the legal and regulatory system, as well as better governance at public pension funds to properly deal with all these issues? You bet we do!

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