Wednesday, November 26, 2008

The Final Bell?

The stock market bolted higher Wednesday, propelling the Dow Jones industrials and Standard & Poor's 500 index to their first four-day advance since last spring:

The market reversed losses from earlier in the session after President-elect Barack Obama pledged he would have a plan to deal with the nation's economic crisis on his first day in office. After filling more spots to his economic team, Obama stated that "help is on the way."

The major indexes built on their gains through the afternoon, but analysts warned that this latest advance came on light pre-holiday volume. The Dow is up 1,174 points, or 15.5 percent, during the past four days, and the S&P 500 is up 135, or 18 percent -- giving both indicators their biggest four-day rise since the Great Depression. The rally marks a string of gains that seemed impossible to achieve in the depths of selling that began in mid-September after the collapse of Lehman Brothers Holdings Inc.

Analysts saw encouraging signs in the rally, but they were still cautious given months of extreme market volatility.

"Sentiment has turned slightly more positive over the past few days with some of the government packages in the U.S. and the stimulus programs that have been announced," said Michael Sheldon, chief market strategist at RDM Financial Group. "That might help turn the tide."

The government's latest steps aimed at restoring the nation's financial system to health came Tuesday, when the Bush administration and the Federal Reserve pledged $800 billion to boost lending on credit cards, auto loans, mortgages and other borrowing.

Obama's remarks, meanwhile, calmed the market after the day's economic reports pointed to more weakness. The government reported that unemployment at recessionary levels, new home sales at their lowest level in nearly 18 years, another plunge in consumer spending, and factory orders for big-ticket items down by the largest amount in two years.

The volume is light but I think the buying will continue after Thanksgiving and all the way till the end of the year. Think about it like a boxing match and the final bell has rung. Pension funds, mutual funds and hedge funds need a good rally going into Christmas.

Speaking of the final bell, the big announcement today was that the Bell Canada deal may be in jeopardy due to solvency issues:

The largest leveraged buyout in history is unlikely to close after the Canadian telecom company BCE Inc. said Wednesday an audit has found the proposed $35 billion deal to take the company private may not meet solvency requirements.

An investment group led by the Ontario Teachers Pension Plan Board and several U.S. partners had expected to complete its deal for BCE, the parent of Bell Canada, on Dec. 11. It would have been the biggest takeover in Canadian history.

A preliminary review by accounting firm KPMG found that BCE would not meet the solvency tests of the privatization agreement, partly due to the amount of debt involved in the transaction and current market conditions, BCE said. The company must meet the solvency requirements for the acquisition to be completed.

BCE spokesman Mark Langton said if KPMG doesn't change its mind, the deal is unlikely to proceed because the auditor must clear it as a condition of closing.

"We are disappointed with KPMG's preliminary view of post-transaction solvency, which is based on numerous assumptions and methodologies that we are currently reviewing. The company disagrees that the addition of the (leveraged buyout) debt would result in BCE not meeting the technical solvency definition," BCE Chief Financial Officer Siim Vanaselja said in a statement.

BCE said it is working with KPMG and the proposed buyers to meet the closing requirements.

Shareholders overwhelmingly approved the buyout group's offer of 42.75 Canadian dollars per share ($34.50) in September of 2007.

BCE management had agreed to the deal in June 2007, just before credit markets began to unravel in North America.

U.S.-listed shares of BCE plunged $10.65, or 34.1 percent, to $20.63 in Wednesday trading. The stock has ranged from $25 to $40.44 over the past year.

If the deal doesn't proceed, the banks that agreed to finance it would be off the hook. Citigroup is directly on the hook for at least $11 billion of the $35 billion in loans backing the deal. The Royal Bank of Scotland, Toronto-Dominion Bank and Deutsche Bank were to provide the rest. The inability of the banks to finance the loans could have meant billions of losses for the banks.

Some analysts speculated the banks would try to get out of the deal. A spokeswoman for Citigroup declined comment.

Jeffrey Fan, an analyst with UBS, said in a report that underfunded pension liabilities at BCE might have been one of the reasons for KPMG's decision.

Elliott Soifer, vice-president of Desjardins Securities International, said he doubts the deal can be salvaged by altering terms.

"Given the market conditions and the amount of debt, the size of the deal and the number of parties involved it's going to be very difficult for them to come to some sort of agreement," Soifer said.

Michael Hlinka, an independent financial analyst and business commentator with CBC radio, said the economic outlook has changed fundamentally since mid-2007. U.S.-listed shares of Telus, one of BCE's competitor's in Canada, have fallen below $28 from a high of over $61 in June 2007.

"When the deal was originally struck the valuations for all publicly traded companies was fundamentally different than what it is now," Hlinka said. "I would be stunned if it goes ahead at this point. The market is voting with its feet right now about the likelihood of the deal. This was supposed to close in two weeks. The financiers are breathing a huge sigh of relief and I think they are in no hurry to come back and get this deal done."

Hlinka said it would have taken "a miracle" for the banks to sell the debt in debt markets.

"Citigroup, for all intents and purposes, is a liability of the U.S. taxpayer. The Royal Bank of Scotland, for all intents and purposes, is a liability of the taxpayers of Great Britain. It's so bizarre that its come to this but it has," Hlinka said.

The Toronto-based Ontario Teachers' Pension Plan -- with assets of $108 billion Canadian ($85 billion) in 2007 -- invests and administers the retirement funds for Ontario's 353,000 active, inactive, and retired teachers. U.S.-based Providence Equity Partners and Madison Dearborn Partners LLC are also involved in the proposed buyout. Teachers' spokeswoman Deborah Allan declined to comment.

I hate to say that I told you so, but I told you so this past Sunday. This deal was DOA and Teachers should count its lucky stars it is off the hook, cut its losses, and just walk away.

Of course, pension funds that invested in Bell thinking this deal will go through just got burned. Moreover, the Bell bombshell hit hedge funds hard:

Some event-driven hedge funds won’t have much to be thankful for tomorrow. Wednesday’s news that Bell Canada’s $50 billion leveraged buyout — the largest in history — is in jeopardy will likely hammer several big funds that were gaining confidence the deal would close on Dec. 11.

Among the big names that owned Bell Canada shares are hedge funds Paulson & Company, D.E. Shaw and S.A.C. Capital. An arbitrage fund run by BNP Paribas also held about $129 million worth of Bell Canada stock at the end of September, according to public filings.

Other funds that held a substantial amount of shares as of Sept. 30 included Chesapeake Partners, Mason Capital Management, York Capital Management and Highbridge Capital Management.

Bell Canada shares were down as much as 40 percent in premarket trading after the telecom giant said Wednesday that a preliminary report by the auditor KPMG found that “given current market conditions,” it would not remain solvent once it took on the $33 billion in debt needed to take it private.

Providence Equity Partners, Madison Dearborn Partners, the Ontario Teachers Pension Plan and Merrill Lynch agreed to buy Bell Canada last year for $42.75 Canadian dollars a share.

A failure of the Bell Canada deal would be the latest in a string of hits this year for hedge funds that bet on takeover deals. Across the globe, 297 deals were shelved in the third quarter, according to Dealogic.

As early as last week, investors were snapping up shares of Bell Canada, narrowing the gap between the stock price and takeover price to less than 10 percent. That gap was once as wide as 30 percent as investors grew fearful of deals falling apart.

Confidence that Bell Canada would close on time was bolstered last week after Providence Equity and Madison Dearborn made “capital calls” to their investors, signaling they were readying their checks to finance the deal. The government’s bailout of Citigroup, one of the lead lenders on the deal, also reassured investors that the deal would close.

Now imagine if a pension fund bought Bell Canada shares thinking the deal would go through and also invested with these hedge funds who thought the deal would go through. That is some significant exposure to the Bell Canada deal.

Oh well, let's see what round #12 will bring. Tomorrow is U.S. Thanksgiving and I will come back with a guest commentary by Bill Tufts from WB Benefit Solutions. I wish everyone down south a happy Thanksgiving.

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