It's Official... I threw in the towel on BCE

This week’s edition of the newsletter may not be popular with some of you.

In fact, I’ve already gotten some pushback from it.

But, in the world of investing, being popular isn’t the goal. The goal — at least for me — is to build a portfolio that delivers consistently increasing dividends, with moderate capital gains. Those two forces should combine for me to hit my 10% hurdle rate target, all while taking considerably less risk than the market.

If a stock in my portfolio no longer checks those boxes, then it’s time to say bye-bye.

That’s exactly what I did with BCE (TSX:BCE) this week. It wasn’t easy pulling the plug on a six year relationship, but it had to be done for the overall health of my portfolio.

Here’s why I did it.

The background

I first bought BCE back in 2018. I paid just over $50 per share during the last quarter of that year, taking advantage of a short-term market selloff to get what I thought was a pretty good deal.

I added more in 2020 and again within the last year.

The thought process was the same each time. BCE was a stodgy company that generated loads of cash flow. I was confident that cash flow would continue to flow pretty much no matter what. Sure, it was spending pretty aggressively on capital expenditures to upgrade its network, but eventually the upgrade cycle would be finished and free cash flow would increase drastically.

That was the message BCE gave investors throughout 2022 and 2023. Sure, we’re borrowing hard now, but just wait a few years. Then we’ll be okay.

Unfortunately, right around that time, macroeconomics decided to punch BCE in the gut. Interest costs went up, forcing the company to borrow at higher rates. This also caused investors to start worrying about the mountain of existing debt BCE would have to refinance.

The company was also hit by additional competition in the wireless space. Quebecor purchased Freedom Mobile from Shaw (who had to divest from wireless as part of the Rogers acquisition) and immediately went about trying to capture market share.

A full-blown price war quickly engulfed the sector, and BCE was caught in the middle of it.

The turnaround plan

Entering 2024 it was obvious BCE needed a turnaround plan.

Management agreed, and embarked on what I thought was a reasonable strategy. It included:

• Cutting costs by laying off large chunks of its bloated workforce

• Decreasing capex expenses by slowing down its network expansion plans

• Planning to off some non-core assets and use the proceeds to pay off debt

I was most optimistic about the non-core assets part. BCE owns 37.5% of Maple Leaf Sports and Entertainment. It also owns 19% of the Montreal Canadiens. Neither of those investments generate a nickel of cash flow for BCE shareholders.

The logical step would be to sell both those investments — plus some other non-core assets — and use the proceeds to pay off debt. That move alone would improve cash flow by eliminating the interest expense on the debt.

That, combined with lower capex costs and lower operating costs from staff layoffs, and I was optimistic that BCE could bring down its dividend payout ratio to under 100% of free cash flow. 

Then I figured that such moves would then be enough to get investors excited about BCE again. It would regain its title as a boring dividend stock and investors would once again consider it for their portfolios.

So I was delighted when BCE sold its MLSE stake to Rogers for $4.7B. This is good! I want them to do this!

I was further emboldened when BCE’s management specifically said the proceeds would be used to pay down debt. That was exactly what I wanted to hear.

The Ziply deal

Imagine my surprise when six weeks after BCE’s management told investors they were paying off debt the company did a sudden about-face.

Just kidding! We’re actually going to expand!

BCE agreed to pay approximately $7B for Ziply Fibre, a wireline telecom with operations in Washington, Oregon, Idaho, and Montana. It has approximately 330,000 fibre customers, with a total of about 400,000 customers. Some customers are using older copper lines, which haven’t been upgraded yet.

BCE’s CEO made the rounds and talked up the acquisition. He essentially told the market this was a wonderful growth opportunity that the company couldn’t pass up. Ziply, you see, is about a third of the way into an ambitious plan that will see it upgrade its entire network to state-of-the-art fibre. The growth potential is huge!

So I listened to the conference call. I watched CEO Mirko Bibic talk up the deal on BNN Bloomberg. And what I saw was a very excited CEO going up against various foes that were all pretty bearish.

But most importantly what I saw was a CEO who repeatedly didn’t answer a very simple question — what will this Ziply expansion cost? We know how much the deal itself will cost. What we don’t know is how much it’ll cost to upgrade that network.

Both the CEO and CFO declined to answer what I thought was a very simple question.

The big problem with Ziply

The more I dug into, it the more the Ziply deal just didn’t make sense — at least from my perspective as a BCE investor.

That’s not to say the deal makes no sense. BCE is confident that Ziply will grow as the network’s grows. A certain amount of disgruntled customers will switch, which will be pretty much pure growth for Ziply.

But there are two issues with that plan. One, as BCE shareholders already know, upgrading wireline networks is expensive. It requires a lot of capex. And two, Ziply isn’t the only game in town. Most of the communities serviced by Ziply have legitimate local competition, including from some of the biggest telecoms in the United States. These aren’t ma and pa local competitors. They’re big guys like T-Mobile and Comcast.

Bibic made it sound BCE would just waltz into these markets, upgrade the equipment, and pick up all the money that fell from the sky. But I’m not nearly that optimistic, and BCE doesn’t have much experience going up against deep-pocketed U.S. telcos.

It’s also easy to argue BCE paid too much for Ziply. The acquisition price was more than 14x the total value of Ziply’s EBITDA. BCE could’ve used the capital to buy back its own shares at about half that valuation.

But ultimately the real reason I sold is I just don’t think BCE can afford to continue upgrading its Canadian network, pay for the Ziply expansion, AND afford its dividend. One has to go, and I believe it’ll be the dividend. 

BCE’s dividend

BCE’s execs know that most investors are in the stock for the succulent dividend, so they made sure to point out that the dividend would be safe.

They even made small moves to ensure the stability of the dividend. The company officially said that the dividend would stay the same in 2025 — there would be no growth there. And it would create a new dividend reinvestment plan (DRIP) to encourage investors to take their dividends in the form of new shares. The incentive to do so will be a 2% discount versus taking dividends in cash.

There are numerous things wrong with this plan, however:

1. It looks exceedingly likely the payout ratio will stay above 100% of free cash flow. This dividend plan didn’t address that at all

2. Diluting existing shareholders creates an even bigger dividend obligation down the road

3. BCE’s management broke their promise about using the MLSE sale proceeds to repay debt. Why should we believe the next promise?

The big question mark continues to be how much BCE will have to spend on Ziply capex. Even if it cuts down Canadian expansion efforts to do that, it still creates a scenario where the payout ratio exceeds 100% of free cash flow.

Why’d I sell?

A few months ago I wrote about why I sell a stock.

Essentially, I’ll sell for one of any of the following five reasons:

1. Thesis creep — If I buy a stock for one reason and the reason to keep owning it changes, then it’s time to sell

2. Lack of earnings growth — Sell when there is ample evidence of no earnings growth per share

3. Dividend cut — Automatically sell when there’s a dividend cut

4. Acquisition — Automatically sell when a stock gets a believable takeover offer

5. Ridiculous valuation — Consider selling when a stock gets too expensive to justify owning it any longer

BCE violated rule one and rule two, plus I think the odds of a dividend cut are well over 50%. So I’m getting ahead of rule three.

The bottom line

Hopefully this explains a little more why I decided to sell.

I’ll also point out that I haven’t thrown in the towel on the entire telecom sector, either. I still hold Telus shares, and I recently bought more Quebecor to put in my TFSA. 

BCE is in the penalty box because the company abandoned what I thought was a perfect reasonable turnaround plan for the newest shiny thing. The proverbial house is on fire and instead of calling the fire department, BCE started looking for a new house.

That new house might be a perfectly nice place to live, once it’s completed. But it’ll be expensive. And I just don’t think BCE has the cash flow needed to build the new house, fix the old house, and pay the dividend.

Breaking up always hurts, but it needed to be done.

One more thing…

Canadian Dividend Investing has one mission — to help our readers select excellent dividend stocks. 

We’re a little different than your average newsletter. We don’t breathlessly await the release of our next stock pick, a name that promises to be the BEST EVER!!!. We leave that up the next WWE pay-per-view — or our competitors.

Instead we help subscribers choose boring, stodgy dividend stocks with potential for those payouts to increase in the future. We scour the TSX looking for both large-caps that fit the bill, plus an interesting collection of small-caps that are also interesting.

Like iA Financial (TSX:IAG), which we first featured in September, 2023. The stock is up more than 50% since it was featured, plus the dividend has been raised. Twice, in fact.

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