At this point, Manitoba Telecom Services should take what it can get for its Allstream division, even give it away if it can't find a buyer, because every day the company hangs on costs shareholders money.
The division has been for sale for months, with little indication of significant interest at the price that MTS was seeking. The Globe and Mail reported almost a year ago that MTS was once again canvassing for buyers, which MTS later confirmed. Since then, it has been largely silent, saying only of late that the process is ongoing.
But that's only the latest sale process. In reality, bankers have long said that Allstream has consistently been for sale for the past couple of years. The big players in telecommunications in Canada have looked and passed.
And all that time, MTS has been pouring cash into the division to support its capital expenditures to connect more buildings to its national office telecommunications network, and to fill its pension deficit.
As MTS says in its disclosure, "Allstream has had negative free cash flow in recent years, which hinders our ability to make necessary re-investments into our business and infrastructure without using new capital. While our current business plan expects Allstream to be in a positive cash-flow position, there can be no assurances that management will be able to deliver on this plan."
How bad is the negative free cash flow?
Analyst Dvai Ghose at Canaccord Genuity estimates it was negative $10-million in 2011, negative $13-million in 2012, and will be negative $25-million this year after accounting for the fact that MTS is using letters of credit to cover pension funding deficits. Three years ago, the division was as much as $80-million cash-flow negative, MTS Chief Executive Officer Pierre Blouin said in February. Yes, there are signs that the division is moving slowly in the right direction, as Mr. Blouin contends. The cash flow hole is shrinking, and earnings before interest, taxes, depreciation and amortization are growing. And people who know him say that Dean Prevost, the head of Allstream, is a great executive and perhaps the most valuable asset at the company.
That is probably not enough to make Allstream sustainable any time soon. Allstream has a weak strategic position, summarized in a February report by Mr. Ghose: "Allstream has some of the key challenges of an incumbent (legacy revenue, pension deficits, union exposure), as well as some of the key negatives of a new entrant (lack of market share and pricing power, reliance on incumbent asset, lack of FCF)." The fibre network is solid, but buyers are scared off by all the other issues.
Allstream also drags down the overall company's margins, and the earnings it generates garner a lower valuation than the earnings from the core business of selling phone, wireless and Internet services to Manitobans. The cash it sucks up prevents dividend increases.
A look at the upside shareholders are missing because of Allstream is instructive. Take Bell Aliant, a regional carrier that in many ways looks a lot like MTS would look shorn of Allstream. Aliant has given shareholders a return of 33 per cent over the past three years, almost double the 18 per cent from MTS. There's an argument that MTS would trade even more strongly than Aliant if Allstream was gone, because MTS would be a takeover target for a wide range of suitors, while Aliant is controlled by BCE.
The implication of all this is that at this point, who cares about the price MTS gets for Allsteam? Just get rid of the millstone. Sure the $1-billion bullish folks were expecting last year would be nice. So would the $500-million MTS was said to be seeking. But that's not happening. If the bid is more like $300-million, as was bouncing around in recent days, MTS should take it. In fact, if there is any bid at all, MTS should jump on it.
There would be some disappointment, because Allstream does account for perhaps $7.50 of MTS's share price based on a valuation of about $500-million. But the long-term implications, as Mr. Ghose has pointed out, are grim if MTS hangs on to Allstream. The sustainability of the parent company's dividend becomes questionable, and the company might have to lever up to raise money to cover cash flow shortfalls and fund the payout to shareholders.
Even if there isn't a buyer, MTS should still take a hard look at simply handing the business to shareholders via a spinoff. It has certainly been pitched to management, which is said to be leery of the idea because the business would have trouble standing on its own.
But if a business can't stand on its own, and requires MTS to continue pouring shareholder money into it, is that really an argument for keeping it? If it is, it sure seems backward.
(Boyd Erman is a Globe and Mail Reporter & Streetwise Columnist.)
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Editor's note: An earlier version of this story mistakenly had "Aliant" in place of "Allstream" in the following sentence: "The implication of all this is that at this point, who cares about the price MTS gets for Allstream?"