BCE shares drop 9% after paying $5-billion for U.S. internet provider Ziply and pausing dividend hikes

Bell Canada parent BCE Inc. BCE-T is expanding into the United States by acquiring internet provider Ziply Fiber for $5-billion, while also putting dividend hikes on hold in order to help fix its balance sheet.

Investors showed frustration with the news by sending BCE’s stock 9 per cent lower in early trading on Monday. The company’s shares, now worth around $40.50 each, are trading for the same price they did in late 2011.

With the acquisition, announced Monday, Canada’s largest telecommunications company will operate in four U.S. states in the Pacific Northwest – Washington, Oregon, Montana and Idaho – and provide fiber internet services to 1.3 million residential and business locations. BCE hopes to upgrade more of Ziply’s copper wire network to faster fiber over the next four years, bringing its total fiber connections to three million.

BCE chief executive officer Mirko Bibic said in an interview that the acquisition shows the company is on its “front foot.” But the deal is also a gamble, considering investors have worried about BCE’s ability to afford its dividend and pay down debt. Because there is so much financial uncertainty, BCE’s shares have lost 10.8 per cent, including dividends, over the last year, while the S&P/TSX Composite Index has delivered a 25.7-per-cent total return.

Ziply is currently owned by a group of private equity funds led by Searchlight Capital, and to fund its purchase, Montreal-based BCE will use $4.2-billion of cash generated from the sale of its 37.5-per-cent stake in Maple Leaf Sports & Entertainment, the owner of Toronto’s professional hockey, basketball, soccer and football teams. In doing so, BCE is swapping an asset it treated as an equity investment – which meant MLSE’s cash flows did not flow through to BCE’s bottom line – for an operating business whose revenues and profits will merge with BCE’s.

The integration matters because investors tend to judge the riskiness of a company’s debt load by comparing it to annual cash flows: “This is a great trade, in sports terms,” Mr. Bibic said.

However, many investors and analysts expected BCE to put a good chunk of its MLSE proceeds toward debt repayment considering BCE’s debt rating was downgraded by two different rating agencies this summer. Although Ziply generates cash flow, it is currently owned by private equity backers – including three Canadian pension funds – and they have put $2-billion of net debt on its balance sheet.

In all, BCE’s total debt level will remain roughly where it is now. In a brief to clients Monday, rating agency Moody’s Investors Service the deal is “credit positive” for Bell Canada, but has no immediate impact on the company’s ratings or outlook.

To show fiscal restraint, BCE will not hike its dividend in 2025, marking a significant change for the telecom giant. BCE has raised its dividend annually for the past 16 years, and this track record has won over yield-seeking investors, including retail buyers who are nearing retirement or are in retirement.

The pause on dividend hikes is also an about-face from Mr. Bibic, who has said BCE could still increase dividends, just at a slower rate than normal.

The CEO said in the interview that the institutional investor community likely will not be surprised by the pause. BCE’s dividend yield is currently 8.9 per cent, and a number of investors and analysts had suggested that such a pause – or even a cut – was necessary.

In a note to clients on Monday, Bank of Nova Scotia analyst Maher Yaghi called the deal a “perplexing transaction,” sharing doubts that it will be profitable for BCE in the coming years given the high cost of loading new customers and building out more fibre in the U.S.

Mr. Yaghi also questioned the strategy shift. “Investors in Canadian telecom are in the sector for dividends and not in it to get growth; they can get it elsewhere,” he wrote, adding that “no dividend increases in the foreseeable future represents an important strategic change.”

The share prices of Canada’s three-largest telcos – BCE, Rogers Communications Inc. and Telus Corp. – have all struggled of late. After years of easy wins, the companies find themselves in a new era of tepid growth driven by lower immigration levels, aggressive discounting for cable and internet services and cord-cutting.

Until recently, the telcos could count on rising immigration to drive revenue growth – in 2023, the Canadian population increased by nearly 1.3 million people – but Ottawa has since changed course, and sales to newcomers won’t be as robust.

Aggressive discounts have also upended the market, particularly for wireless services. Typically, the telcos only compete with heavy discounts during certain times of the year, such as back-to-school or around Black Friday. But the discounting driven by smaller rivals such as Freedom Mobile has been persistent for more than a year, and it is putting sustained pressure on revenues.

As for cord-cutting, or the act of Canadians cancelling their cable television services, the trend has plagued the sector for years. But lately, it’s hit with more intensity, as streaming services capture additional market share.

Each telco also has its own unique challenges. In BCE’s case, the company has bet heavily on its fibre buildout. Under Mr. Bibic’s watch, BCE has borrowed heavily to upgrade its fibre networks – total debt now sits at $39-billion – with the expectation that customers will eventually pay more for faster speeds.

However, the build out has taken years, and the aggressive discounting is making it harder to recoup these investments.

At the same time, some analysts recently discovered that BCE’s dividend was arguably more costly than expected. Once certain costs are factored in, the telco has been paying out more than 140 per cent of its free cash flow each year, which is unsustainable.

After the debt rating downgrades the year, BCE’s decision to sell its MLSE stake suggested the company was prioritizing debt repayment. Mr. Bibic, though, said Ziply’s owners approached him near the end of those negotiations. While he couldn’t say much publicly, he figured the MLSE sale “was either going to allow us to significantly reduce debt or seize the growth agenda that we had in mind.”

Searchlight Capital acquired Ziply in 2019 for US$2-billion. Three Canadian pension funds – the Public Sector Pension Investment Board, British Columbia Investment Management Corporation and Canada Pension Plan Investment Board – are co-owners of the business, along with U.S. telecom-focused private equity fund WaveDivision Capital, LLC.

The purchase marks a return to the United States for BCE after purchasing long-distance carrier Teleglobe Inc., which had significant U.S. operations, in 2000. Teleglobe filed for creditor protection in 2002 after the dot-com bust, and BCE wrote down billions of dollars.